January 2013 - June 2013
No. 12-2296, 2013 WL 1095445 (3rd Cir. March 18, 2013)
North American Steel Connection, Inc. (“NASCO”), a Louisiana corporation, entered into a joint venture with Watson Metal Products Corporation (“Watson”), a New Jersey corporation, and another corporation. The joint venture was structured as a Delaware LLC. No formal contract memorializing the terms of the joint venture was executed, and the parties established by informal conversations and emails the roles of the three corporate members. When the joint venture was established, Ostermueller was Watson’s president and majority shareholder. After the joint venture began, accounting disagreements arose between NASCO and Watson. Watson and NASCO entered into an agreement requiring Watson to make certain payments to NASCO to rectify errors involving the misuse of joint venture funds. Eventually, the members of the LLC signed an agreement providing that the members other than NASCO would withdraw, leaving NASCO as the only member of the LLC. After Watson defaulted in the payment of funds owed NASCO, NASCO sued Watson and Ostermueller alleging various causes of action. After determining that there was insufficient evidence to support piercing Watson’s corporate veil to hold Ostermueller liable for Watson’s acts as well as insufficient evidence to show that Ostermueller personally participated in Watson’s mishandling of the LLC’s funds, the court turned to NASCO’s argument that Ostermueller was a manager of the LLC and was liable as such to NASCO for breach of fiduciary duty. The court of appeals agreed with the district court that there was no evidence that Ostermueller was in fact a manager of the LLC. The court stated that, under Delaware law, a manager must be named as a manager in an LLC agreement or similar instrument. Once so designated, a manager has the authority to bind the LLC and owes the traditional fiduciary duties of loyalty and care to the members of the LLC unless those duties are modified or eliminated in the LLC agreement. According to the court, a manager of an LLC is not simply someone who assumes management responsibilities. NASCO pointed to only two instances in which Ostermueller was referred to as a “manager:” an email in which he offered to resign as manager, and a reference in his affidavit to being the manager. The court stated that Ostermueller could not have unilaterally established himself as manager under Delaware law through such statements, and there was no evidence presented that the members of the LLC agreed that he would occupy that position or in fact exercised management authority. Thus, no reasonable jury could find that he was in a fiduciary relationship with NASCO, much less that he was liable for breach of a fiduciary duty, and the district court did not err in granting summary judgment to Ostermueller on the breach of fiduciary duty claim.
716 F.3d 342 (4th Cir. 2013)
An LLC and its owners alleged that the LLC’s landlord and its agents, motivated by racial animus, interfered with the LLC’s restaurant business and the LLC’s opportunity to sell the restaurant in violation of federal anti-discrimination laws (42 U.S.C. §§ 1981, 1982, and 1985) and state law tort principles. The plaintiffs alleged that the defendants spoke about the LLC’s clientele using racial slurs and engaged in various acts of harassment after the LLC’s clientele became predominantly African American. The court of appeals affirmed the district court’s dismissal of the LLC’s owners as plaintiffs based on lack of standing. The appellate court pointed out the individual plaintiffs chose to conduct their business as an LLC, which provided them liability protection and resulted in their becoming agents of the LLC. In doing so, they gave up standing to claim damages for the LLC, even if they also suffered personal damages as a consequence. The court relied on the United States Supreme Court’s decision in Domino’s Pizza, Inc. v. McDonald, 546 U.S. 470 (2006). In that case, the sole shareholder and president of a corporation alleged that Domino’s breached its contract with the shareholder’s corporation based on racial animus toward the shareholder and that Domino’s injured him personally. The Ninth Circuit recognized the shareholder’s claim, but the Supreme Court held that a plaintiff cannot state a claim under 42 U.S.C. § 1981 unless the plaintiff would have rights under the contract at issue; § 1981 plaintiffs must identify injuries flowing from a racially motivated breach of their own contractual relationship, not of someone else’s. Thus, Domino’s directly foreclosed the individual plaintiffs’ § 1981 claim, and the court of appeals held that the same principles applied to the §§ 1982 and 1985 claims. For similar reasons, the court held that the individual plaintiffs did not have standing to assert claims based on state law tortious interference with contract and economic relationships. The court dismissed the plaintiff’s conspiracy claim because it was based on the wrongful acts of individuals who were employees of an LLC and its parent. The plaintiff alleged that the defendants conspired to deprive it of equal protection in violation of 42 U.S.C. § 1985(3). The court applied the intracorporate conspiracy doctrine, which provides that a corporation cannot conspire with its agents because the agents’ acts are the corporation’s own acts. Given that the complaint alleged that the three conspirators were also agents of the LLC and its parent, it could not allege a conspiracy between two or more persons unless an exception to the intracorporate conspiracy doctrine applied. The court rejected the plaintiff’s argument that it sufficiently alleged an exception, i.e., that the individual defendants had an independent personal stake in achieving the corporation’s objective, which was racial animus. The court concluded that the plaintiff did not allege that the individual defendants had a personal stake independent of their relationship to their employer or that they were acting outside the scope of their employment.
714 F.3d 274 (5th Cir. 2013)
At issue in this adversary proceeding was the validity of a multiple indebtedness mortgage and whether the LLC’s real property covered by that mortgage secured a subsequent loan made to a second entity. A recorded acknowledgment signed by the LLC’s sole member provided that the LLC was jointly and severally liable for the second entity’s loan and that the multiple indebtedness mortgage secured the second entity’s loan. As part of the court’s analysis, the court discussed whether the member had authority to pledge the multiple indebtedness mortgage to secure the other entity’s debt. Under the Louisiana LLC statute, a managing member of an LLC may act as an agent for all matters in the ordinary course of its business other than the alienation, lease, or encumbrance of the LLC’s immovables. Unless otherwise provided in the LLC’s articles of organization or a written operating agreement, a majority vote of the members is required to approve the alienation, lease, or encumbrance of any immovable of an LLC. The LLC argued that there was no valid written resolution authorizing the managing member to pledge the multiple indebtedness mortgage to secure the other entity’s loan. The court concluded that the member was the sole managing member and that he had the authority to pledge the multiple indebtedness mortgage “based on the relevant law, and also based on common sense.” The member signed a resolution granting himself the authority to pledge all of the LLC’s real property as security for any indebtedness of the LLC to the lender, and the resolution thus comported with the requirement that a majority of an LLC’s members approve a manager’s pledge of the LLC’s real property.
__ B.R. __, 2013 WL 1694769 (6th Cir (B.A.P.) 2013)
The court in this appeal addressed whether the bankruptcy court abused its discretion in denying the application for administrative expenses of the West Virginia Department of Environmental Protection (WVDEP) against two affiliated Chapter 11 debtors. The affiliated debtors were a Kentucky LLC and a West Virginia LLC, and the court first analyzed whether they had derivative liability for the expenses of a third affiliate, a West Virginia corporation. The court discussed the U.S. Supreme Court’s decision in United States v. Bestfoods (which involved liability under CERCLA) as a helpful tool in analyzing liability for administrative expenses under the state environmental statutes at issue in this case. In Bestfoods, the Supreme Court did not answer the question of whether courts should borrow state law or apply a federal common law of veil piercing when enforcing CERCLA’s derivative liability, but the Sixth Circuit has held that courts should borrow state law, and the court thought the same analysis should apply to derivative liability under the environmental statutes at issue in this case. The court then addressed the question of which state’s law should apply here given that the three affiliates involved consisted of a West Virginia corporation, a West Virginia LLC, and a Kentucky LLC; these affiliates filed bankruptcy in Kentucky; and the mining operations that caused the environmental damage took place in West Virginia. The court discussed veil piercing under Kentucky and West Virginia law and stated that West Virginia law is more favorable to parties seeking to establish the LLCs’ derivative liability for the debts of its affiliated or sister corporation than Kentucky law since there is no reported decision in Kentucky recognizing the ability to pierce the veil of one corporation to reach its sister corporation. Ultimately, the court determined that the evidence was insufficient to pierce the corporate veil and impose liability on the two LLCs under either West Virginia or Kentucky law. Additionally, the court determined that substantive consolidation did not provide a basis to impose joint liability on the LLCs for the administrative expense claims because joint procedural administration of bankruptcy cases does not result in the same melding of estates as substantive consolidation. Finally, the court analyzed the direct liability of the LLCs under the environmental statutes at issue and concluded that the bankruptcy court abused its discretion when it denied the administrative expense claim of WVDEP against one of the LLCs based on the theory of direct liability.
No, 12-8018, 2013 WL 197399 (6th Cir. (B.A.P.) Jan. 18, 2013)
The debtor appealed the bankruptcy court’s ruling that the debtor could not claim a homestead exemption in real property under Ohio law because the real property was owned by an LLC. The court cited case law and provisions of the Ohio LLC statute distinguishing between a member’s membership interest in the LLC and property of the LLC. In attempting to predict what the Ohio Supreme Court would rule if presented with the issue, the court relied on an unpublished decision from the Northern District of Ohio and a Massachusetts bankruptcy court decision in which the courts concluded that the debtors did not have an exemptible interest in property owned by a wholly owned LLC. The court rejected the debtor’s argument that the most important element under the Ohio homestead exemption statute is “use” of the property and that it trumps all other elements, including holding an “interest” in the property. Because the residence at issue was the LLC’s property, the debtor held no specific interest in the LLC’s property under Ohio LLC law. Because the Ohio exemption statute allows the debtor to exempt the debtor’s interest in the property used as a residence, the debtor could not claim an exemption. Further, the debtor could not claim a homestead exemption because the property was not property of the bankruptcy estate. Property of the estate consists of the legal or equitable interests of the debtor in property at the time of the commencement of the case. Property cannot be exempted unless it first falls within the property of the bankruptcy estate, and the debtor’s membership interest in the LLC gave her no specific or cognizable legal interest in the real property at issue. Accordingly, the property was not property of the estate, and she was not entitled to claim an exemption in it.
488 B.R. 394 (9th Cir. (B.A.P.) 2013)
A member of a California LLC invoked a withdrawal provision of the LLC operating agreement, triggering a process in which the LLC and withdrawing member would use their best efforts to agree upon the fair market value of the member’s interest. After an appraisal failed to result in a value to which the LLC agreed, the withdrawing member initiated an arbitration proceeding that resulted in a determination that the LLC was bound by the value determined by the appraiser. The arbitrator awarded the appraised value as damages, and the arbitration award was confirmed by a California court and reduced to judgment. An abstract of judgment was recorded. The LLC filed a Chapter 11 bankruptcy case, and the LLC filed this adversary proceeding seeking mandatory subordination of the withdrawn member’s judgment under Section 510(b) of the Bankruptcy Code. Section 510(b) provides that a claim for damages arising from the purchase or sale of a security of the debtor or an affiliate of the debtor shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except that if the security is common stock, the claim has the same priority as common stock. The court determined that a membership interest in an LLC is a “security” for purposes of this provision although the Bankruptcy Code definition of a “security” does not mention a membership interest in an LLC. Since the fifteen-item list of what constitutes a security in the definition is not exclusive, the court looked for an analogous item in the list and determined that the inclusion of the interest of a limited partner in a limited partnership led to the conclusion that the interest of a member of an LLC is also a security based on the similarities between the two types of interests. The court next concluded that the confirmed arbitration award was “for damages” within the meaning of Section 510(b). The court examined the general meaning of “damages” and rejected the argument that “damages” must arise from wrongdoing or malfeasance. Because the arbitration award was an order to pay money as a matter of contractual right and achieved the status of judgment debt, the arbitration award and judgment qualified as “damages” under Section 510(b). The court next addressed the question of whether the withdrawn member’s claim was a claim “arising from the purchase or sale” of the LLC’s securities. The withdrawn member claimed that her claim was an ordinary debt obligation because she withdrew, shed her equity status, and became a general creditor before the bankruptcy proceedings. The court discussed the ambiguous nature of the phrase “arising from” and concluded the Ninth Circuit favors a broad reading of the phrase. The court examined the legislative history of Section 510(b) and concluded that two rationales underlying Section 510(b) supported mandatory subordination: (1) the dissimilar risk and return expectations of shareholders and creditors; and (2) the reliance of creditors on the equity cushion provided by shareholder investment. As to the first rationale, the withdrawn member was an equity holder before she withdrew, enjoyed a considerable return during her tenure as member, and received an arbitration award that was directly linked to her ownership of a membership interest because it constituted the cashing out of her equity. Second, the court presumed that creditors relied on the equity cushion created by contributions to capital, and the withdrawal of the member in this case and liquidation of her interest altered, or attempted to alter, the balance sheet by extracting her contribution and deflating the equity cushion. Even if the withdrawn member had argued that there was a lack of creditor reliance, the presence of the first rationale was sufficient to support a holding that Section 510(b) is broad enough to encompass a claim that arose from the withdrawal of an LLC member triggering a repurchase process by which the debtor was obligated to buy back the interest. The court rejected the argument that the withdrawal from the LLC and fixing of the claim before bankruptcy rendered the claim a “fixed debt” and prevented mandatory subordination. The court noted that this was not a case involving “a transformation of equity into debt in a transaction that is old and cold and that has long been treated as a part of the enterprise’s debt.” Rather, “the dispute over the buy-back amount and the chapter 11 filing were sufficiently proximate in time to warrant the conclusion that this is an effort by equity to capture paper (and arguably mythical) profits via a judgment for money damages.” In sum, the court concluded that the claim was so firmly rooted in the withdrawn member’s equity status that subordination was mandatory.
484 B.R. 766 (9th Cir. (B.A.P.) 2013)
The debtor could not avoid a judgment lien on his homestead under the exemption impairment provision of the Bankruptcy Code where the debtor acquired the homestead, transferred it to an LLC, and later reacquired it from the LLC. The debtor had no interest in the property in the interim while it was owned by the LLC, and he thus acquired a different interest to which a lien had attached when he reacquired the property.
United States v. ADT Security Services, LLC
__ Fed. App’x __, 2013 WL 2631435 (11th Cir. 2013)
In this civil forfeiture action, an LLC asserted a claim for a 10% interest in several properties owned by other LLCs in which the claimant held a 10% interest. The claimant also asserted a claim for a 10% interest in escrowed lease payments collected with respect to the properties. The district court granted the government summary judgment on the basis that the claimant lacked standing to assert the claim. The government’s challenge to the claimant’s standing rested in part on the fact that the claimant did not exist as a jural entity. The court discussed the formation and structure of LLCs under Pennsylvania and Florida law, described the history and existence of certain other entities with similar names, and explained that the evidence showed the claimant was never properly formed as an LLC. The claimant argued that it existed as a de facto LLC or an LLC by estoppel, but this argument was not properly briefed and thus was not considered by the court of appeals. The court of appeals next considered whether the claimant was an entity that could make an appearance despite not being properly formed as an LLC. The court concluded that the claimant could make an appearance but lacked standing. Whether the claimant as a non-existent legal entity could assert a valid claim was a question of “substantive standing jurisprudence.” To have standing, the claimant must have an ownership interest in the subject properties as determined by the law of the jurisdiction creating the asserted interest. The properties at issue were owned by Florida and Pennsylvania LLCs in which the claimant claimed to be a member. Under Florida and Pennsylvania LLC law, property acquired by an LLC is property of the LLC, and the claimant thus could not assert a claim on its own behalf. The court next analyzed whether the claimant could assert a claim on behalf of the LLCs in which it claimed to be a member. The operating agreements of the LLCs at issue provided that the LLCs were manager-managed. A member of a manager-managed LLC under the Florida and Pennsylvania statutes does not have authority to act solely by reason of being a member. The claimant argued that it had been elected as a manager, but the court explained that the claimant failed to satisfy its evidentiary burden on this point and thus failed to show it had authority to file a claim on behalf of the LLCs that owned the property. Finally, the court addressed a provision of the Pennsylvania LLC statute that provides that the lack of authority of a member or manager to sue on behalf of an LLC may not be asserted as a defense to an action by the LLC. The court acknowledged that the statute appeared at first glance to bar the government from challenging the claim, but the court concluded that the statute was inapplicable. The court distinguished the filing of an “action” from the filing of a “claim” such as the claim in this forfeiture action. The court relied on commentary to the Pennsylvania statute and to applicable procedural rules allowing the government to challenge the claimant’s standing.
__ F.Supp.2d __, 2013 WL 1225392 (D.D.C. 2013)
The plaintiff registered a group of domain names using the “Riot Act” name, and he and two other individuals subsequently agreed to launch a comedy club in Washington, D.C. The three individuals executed an operating agreement forming an LLC and created a business plan. The plaintiff served as the general manager of the club and worked in a variety of roles for the club. The plaintiff completed paying his $100,000 capital contribution, and the other two members agreed to compensate the plaintiff with an annual salary. Shortly after that, the other two members removed the plaintiff from his management role and arranged to revise the domain name registration information and transfer ownership of the domain names to the LLC. The plaintiff sued the other two members asserting numerous claims against them. The defendants sought to dismiss the plaintiff’s claims. The plaintiff’s breach of contract claim alleged that the defendants breached their duty of good faith and fair dealing by fraudulently inducing the plaintiff to enter into a business relationship with them and then terminating the plaintiff’s participation shortly after the club’s opening. The defendants argued that the plaintiff’s allegations did not specify the express contractual duty owed or how the defendants breached the contract. The plaintiff argued that both the operating agreement and the business plan were contracts and that these contracts recognized his position as the general manager. The court stated that the complaint did not identify any express contractual duty allegedly breached by the defendants. The operating agreement vested broad authority in the managing members to engage and employ members and stated that any action must be approved by a majority of the managing members. The plaintiff’s complaint confirmed that any management decision should be controlled by two-thirds of the Class A members. The plaintiff’s allegations that the defendants terminated employees and removed the plaintiff as general manager did not state a claim for breach of the operating agreement because the defendants were empowered to do so as a majority of the managing members. Whether the business plan was a contract did not need to be resolved by the court because, assuming it was, the plaintiff did not identify any statement in the business plan that created a contractual duty regarding his trademarks that were violated. Thus, the plaintiff’s claim of breach of an express contractual duty failed. The defendants also sought dismissal of the plaintiff’s implied duty of good faith and fair dealing claim. The first portion of the plaintiff’s implied duty claim failed because it alleged that the defendants caused the plaintiff to enter into a business relationship with them and sign the operating agreement, and the court stated that allegations regarding pre-contract negotiations cannot state an implied duty claim under D.C. law. The plaintiff also alleged that the defendants caused the plaintiff to contribute $100,000 and his time, expertise, contacts, business plans, and the right to use the domain names. The defendants argued that the allegations supporting this claim were pre-contract actions of the defendants identical to the plaintiff’s fraudulent inducement claim. The court stated that the allegations for an implied duty claim must have occurred after a contract is executed, but the court found that the plaintiff’s claim for breach of implied duty of good faith and fair dealing survived because the plaintiff alleged that the defendants induced him to contribute $100,000 and continue his efforts in furtherance of the LLC by giving repeated assurances of their continued interest in the business. The assurances were allegedly given before the plaintiff paid his remaining $50,000 contribution and continued to work for the club after execution of the operating agreement. The defendants then allegedly terminated the plaintiff’s participation shortly after the club opened. According to the court, these allegations supported the claim that the defendants evaded the spirit of the contract and interfered with the plaintiff’s performance and, if true, showed that the defendants violated the standard that neither party to a contact may do anything to destroy or injure the right of the other party to receive the fruits. The plaintiff conceded that he had not stated an unjust enrichment claim against the other two members because the existence of an express contract between the managing members of the LLC precluded such a claim, but the plaintiff argued that his unjust enrichment claim against the LLC survived because there was no express contract between the plaintiff and the LLC. The operating agreement did not expressly state whether the LLC was a party, and the D.C. LLC statute in effect when the operating agreement was executed in 2010 did not specify whether an LLC is a party to its own operating agreement. The court noted the differing conclusions reached by the courts in the Elf Atochem decision in Delaware and the Trover decision in Illinois and concluded that, given the D.C. statute in effect at the time and the terms of the operating agreement at issue (which did not list the LLC as a party and provided that the managing members had the power to bind the LLC), the LLC was not a party to the operating agreement, as was the case in the Trover decision. Thus, the principle that a party to an express contract may not assert an unjust enrichment claim did not preclude an unjust enrichment claim against the LLC. Furthermore, because the LLC was not a party to the operating agreement, the court explained that case law precluding a litigant from asserting an unjust enrichment claim where there is an express contract that “governs the parties’ conduct” did not apply either. The court concluded that the complaint’s allegations of uncompensated efforts for the LLC before the agreement to compensate the plaintiff supported an unjust enrichment claim, but the unjust enrichment claim based on plaintiff’s uncompensated efforts after he secured a salary agreement were barred by that agreement.
489 B.R. 124 (C.D. Cal. 2013)
A corporation engaged in the business of originating, servicing, buying, and selling sub-prime mortgages formed two LLC funds to fund its business. The funds had no employees, and the corporation was the sole manager of the funds. The operating agreements of the funds gave the manager authority to manage and direct the funds but required approval of a majority of member shares for certain transactions. The funds engaged in several transactions in which a law firm issued opinions on the transactions as special counsel to the manager and the funds, and the funds asserted malpractice and breach of fiduciary duty claims against the law firm in this adversary proceeding. The law firm sought summary judgment on in pari delicto grounds, arguing that the manager’s wrongdoing (which was admitted by the funds) should be imputed to the funds under principles of corporate and agency law. The court stated that California courts follow the well-established principle that the acts and knowledge of an officer/agent can be attributed to a corporation/principal and that this principle could be applied to the LLC funds with respect to its manager because courts do not differentiate in this context between LLCs and “more traditional corporations.” Furthermore, the court noted that imputation of an officer’s acts to the corporation is simply an application of general agency law. The court then discussed the “adverse interest” exception to attribution or imputation of an agent’s acts to the principal. The “adverse interest” exception is in turn subject to the “sole actor” exception. The court concluded that the manager did not have sole control over the transactions because the operating agreement required member consent to transactions presenting a conflict of interest for the manager. The court said that there was a material issue of fact whether the transactions benefitted the manager at the expense of the funds, and it was thus a disputed issue of fact whether the manager was the sole decision maker under the operating agreement. The court distinguished cases cited by the defendants for the proposition that the adverse interest exception should not be applied to this case because the cases relied on by the defendants involved corporations used by their principals to steal from outsiders, and the manager’s wrongdoing was theft from the funds themselves. Furthermore, in addition to the adverse interest exception, the court stated that California courts refuse to impute the acts and knowledge of an officer in a situation where that officer has no power to bind the corporation. The court stated that the manager’s lack of authority under the operating agreements to bind the funds to the transactions also raised this exception. Because it was a disputed fact whether the manager had the sole authority or any authority at all to enter into the transactions, both the “adverse interest” and “no authority to act” exceptions precluded summary judgment in favor of the law firm. The court also examined the defendants’ judicial estoppel argument and declined to invoke the doctrine on the record before it.
302 P.3d 263 (Colo. 2013)
A creditor of an LLC obtained an arbitration award in federal court against an LLC with two members who were also the only shareholders of the LLC’s two managers. The managers authorized a distribution of the LLC’s assets to the members, which the creditor alleged made the LLC insolvent and unable to pay the award owed to the creditor. The creditor filed suit against the members and managers claiming that the members violated the Colorado Limited Liability Company Act by accepting unlawful distributions and that the managers breached their fiduciary duty to the LLC’s creditors by authorizing the distributions to its members. The defendants filed a motion to dismiss. In the motion, the members argued the plaintiff lacked authority to bring an action under the LLC statute because the statute provided only that members were liable to the LLC for an unlawful distribution. The managers argued that Colorado law did not recognize a common law fiduciary duty owed by managers of an LLC to an LLC’s creditors and that case law allowing creditors of a corporation to recover against the corporation’s shareholders did not apply to LLCs. The trial court agreed with the defendants and granted their motion to dismiss. The court of appeals reversed, holding that the plaintiff had a viable claim for an unlawful distribution against the LLC’s members under the LLC statute because a similar provision of the Colorado Business Corporation Act had been interpreted to provide a cause of action for unlawful distributions to a corporation’s creditors. The court of appeals also held that the plaintiff had stated a proper claim for breach of fiduciary duty against the managers based on prior case law that held an insolvent LLC’s managers owed the same duty to the LLC’s creditors that the directors of an insolvent corporation owe to the corporation’s creditors. The Colorado Supreme Court granted the defendants’ petition for certiorari on two issues: (1) whether the creditors had standing under the LLC statute to sue the members of an LLC who allegedly received an unlawful distribution, and (2) whether the court of appeals erred in extending the common law fiduciary duty an insolvent corporation’s directors owe its creditors to the managers of an LLC. The supreme court generally discussed the LLC statute and the nature of LLCs and pointed out that an LLC is distinct from a corporation, which is governed by corporate law. As to the first issue, the supreme court agreed with the trial court that the LLC statute allows an LLC to state a claim against any member who knowingly receives a distribution that renders the LLC insolvent (i.e., an unlawful distribution) but does not provide for a cause of action for LLC creditors against LLC members. The creditor relied on the similarity of the distribution provision in the corporate statute, which Colorado case law had held conferred standing on creditors to sue directors. The supreme court conducted a statutory construction analysis and concluded that the creditor’s argument was incorrect. The language of the LLC statute creates a cause of action for the LLC against a member for accepting unlawful distributions but does not mention such a cause of action for the LLC’s creditors. The legislature created remedies for an LLC’s creditor in other sections of the LLC statute but not in the circumstances at issue here. The court pointed out that the LLC statute and the corporate statute are two different statutes with different schemes and purposes, and because a corporate shareholder is not equivalent to an LLC member, the legislature was free to choose a statutory limitation on an LLC’s creditors different from what it chose for a corporation’s creditors. Furthermore, because LLCs and corporations are different business entities, common law applicable to corporations does not apply to an LLC in the context of a claim for unlawful distribution. Thus, the supreme court concluded that the LLC statute only permits the LLC to assert a claim against its members for an unlawful distribution, and the creditor could not assert a claim against the members for unlawful distribution absent statutory authority. The court next addressed the question of whether the LLC’s managers owed a common law fiduciary duty to the creditors similar to the fiduciary duty an insolvent corporation’s directors owe its creditors. The creditor argued that the common law fiduciary duty exists in the LLC context and that the managers here breached that fiduciary duty by putting their own interests above the creditor’s by authorizing unlawful distributions. This was a question of first impression for the Colorado Supreme Court. The court had previously held that the directors of an insolvent corporation owe the creditors of the corporation a limited fiduciary duty that requires the directors to avoid favoring their own interests over creditors’ claims; however, the insolvent corporation’s directors do not owe a general fiduciary duty to its creditors. A Colorado court of appeals applied the ruling that a corporation’s directors owe a common law fiduciary duty to the corporation’s creditors to the managers of an LLC in Sheffield Servs. Co. v. Trowbridge, 211 P.3d 714, 723-24 (Colo. App. 2009). The supreme court disagreed with the appellate court. The Colorado LLC statute contains a provision specifying that corporation common law applies to a veil-piercing claim (not alleged here) but not to any other common law claim. The LLC statute extends no fiduciary duty to the LLC’s creditors owed by the managers. Because the LLC statute did not extend corporation common law to an LLC in any instance except a veil-piercing claim, the court of appeals in Sheffield erred in extending the fiduciary duty of an insolvent corporation’s directors to the managers of an LLC, and the court overruled Sheffield to the extent it held that an LLC’s managers have a fiduciary duty to the LLC’s creditors. The court held that absent statutory authority the managers of an insolvent LLC do not owe the LLC’s creditors the same fiduciary duty that an insolvent corporation’s directors owe the corporation’s creditors. Thus, the creditor could not assert a claim of breach of fiduciary duty against the managers.
Cook v. Toidze
__ F.Supp.2d __, 2013 WL 2995349 (D. Conn. 2013)
The plaintiffs, members of an LLC, sued the other members individually and derivatively on behalf of the LLC. The defendants attacked a default judgment taken against them, and the court raised sua sponte the issue of whether the court lacked subject matter jurisdiction. Because an LLC has the citizenship of each of its members, the LLC was a citizen of Canada and Connecticut. The court stated that if the action was a derivative action, the LLC was not a nominal party and its citizenship could not be ignored. The court concluded that the plaintiff’s claims were derivative in nature. The plaintiffs claimed that one of the defendants failed to transfer intellectual property to the LLC, which forced a joint venture to which the LLC was a party to fail to renew a consulting agreement. The plaintiffs also alleged that the defendants engaged in unauthorized travel to meetings that damaged the relationship between a third party and the joint venture to which the LLC was a party. Further, the plaintiffs alleged that the defendants failed to pay their share of a capital call, thereby causing a shortfall in the LLC’s working capital. Finally, the plaintiffs alleged that the defendants continued their efforts to damage the value of the membership interests by interfering with the governance of the LLC. The court held that these allegations described harm to the LLC and were derivative in nature; therefore, the LLC was not merely a nominal party. The court further held that the LLC was an indispensable party (noting that the courts appear to be unanimous in concluding that the party on whose behalf a derivative claim is brought is an indispensable party) whose presence in the suit destroyed diversity jurisdiction, and the default judgment against the defendants was thus void due to lack of subject matter jurisdiction.
66 A.3d 931 (Conn. App. 2013)
The defendants in an action brought by the sole member of an LLC appealed the judgment against them on the basis that the plaintiff did not have standing to assert the claims on which the judgment was based. The plaintiff sued for breach of contract and unjust enrichment based on the defendants’ breach of an oral agreement to purchase a retail women’s clothing store after taking over operation of the store. The store was owned by Clare Jones, LLC, and the plaintiff’s evidence included various documents and proposed drafts of sales contracts, all of which indicated the plaintiff was acting as an agent of Clare Jones, LLC, rather than as an individual. There was no evidence or testimony that the plaintiff individually owned the store or that any of the assets located in the boutique belonged to the plaintiff individually. The court cited statutory provisions regarding the separate legal existence of an LLC and its power to sue and be sued. The court concluded that any harm caused by the alleged breach was to Clare Jones, LLC, and the plaintiff’s status as sole member did not impute ownership of the LLC’s assets to the plaintiff since property acquired by an LLC is property of the LLC rather than its members, and a member has no interest in specific LLC property. The plaintiff thus did not have standing, and the trial court erred in denying the defendants’ motion to dismiss.
60 A.3d 358 (Conn. App. 2013)
The court of appeals concluded that the trial court’s determination that a redeemed member did not receive less than he was entitled to receive under a letter agreement with the LLC was not clearly erroneous. Neither party provided expert testimony, and expecting the court to navigate five years of tax returns, payroll records, promissory notes, and repayment records and perform forensic accounting of capital accounts without expert assistance to conclude there were discrepancies would be unreasonable.
C.A. No. 4586-CS, 2013 WL 1955012 (Del. Ch. May 13, 2013)
The plaintiffs were investors in a Delaware LLC fund formed to invest in retirement homes. Two of the plaintiffs, the former manager of the LLC and the manager’s affiliate, held a 5% ownership interest in the LLC, and the main defendant, the California Public Employee’s Retirement System (“CalPERS”), held the remaining 95% ownership interest in the LLC. The manager and its affiliate claimed that the LLC agreement required CalPERS to pay it an incentive distribution, the value of their 5% membership interest upon their withdrawal as members of the LLC, and asset management fees. CalPERS challenged appraisals valuing the assets of the LLC that were used to calculate the payments. In essence, CalPERS sought a judicial determination of the value of the LLC’s assets. The court first addressed the threshold issue of what judicial standard of review to apply when a party disputes a value determined under a contractually specified appraisal process. The provisions of the LLC agreement governing the appraisal process were based on form contracts prepared by CalPERS, and the provisions gave CalPERS unilateral authority over the process, including the selection of the appraisers. The manager argued that the appraisal process was governed by the LLC agreement and that the court had no ability at all to review the appraisals. CalPERS argued that the court must independently review the appraisals and reach a de novo determination as to the matters assigned to the appraisers under the contract. Because Delaware respects freedom of contract, the court held that a court may not second-guess appraised values that have been determined by appraisers selected according to the terms of a contractual appraisal process unless the process has been tainted by a breach of the implied covenant of good faith and fair dealing, such as concerted bad faith action between the appraiser and the other party. Parties may agree in their LLC agreement to whatever level of judicial review they desire, but the parties here did not provide for any judicial review. CalPERS claimed that the manager breach the implied covenant of good faith and fair dealing in connection with the appraisal process by misleading an appraiser with bullish projections of the future performance of the LLC’s investments, but the court concluded that the evidence showed that the appraiser made its own independent projections, and there was thus no breach of the implied covenant. Because the standard of judicial review was a relatively unique issue as to which the Delaware Supreme Court might differ, the chancery court went on, in the interest of judicial economy, to analyze CalPERS’ arguments attacking the appraisers’ valuation. The court concluded that, assuming it had the power to review the appraisals de novo, the court would reject CalPERS’ attacks on the appraisals and would find that the substantive merits of the appraisals passed muster. The next issue addressed by the court was a dispute between the parties regarding the calculation of cash “distributions” to CalPERS, which affected the incentive distribution payment owed to the manager. CalPERS argued that the calculation of “distributions” was incorrect because the manager included distributions in its calculation but had failed to transfer cash to CalPERS in accordance with the LLC agreement. A “distribution” was defined in the LLC agreement as any cash payment to a member. The LLC agreement provided that cash would be swept into a bank account daily, that the manager would instruct the bank to remit to CalPERS its portion of cash on a monthly basis, and that the funds in the cash management system remained property of the LLC. However, the same section of the LLC agreement also provided that the manager was to manage cash in accordance with cash management policies established by CalPERS, and these policies defined distributions as “deposits made by the partners into the collection account for ordinary income.” The court found that this created an ambiguity in how distributions were to be made. Based on the parties’ course of performance, the court concluded that the parties understood that distributions could be made to CalPERS through the cash management system. The court next addressed the claim of the manager and its affiliate for payment for their membership interests. The LLC agreement required CalPERS to purchase the membership interests when the manager withdrew from the LLC, and the LLC agreement required CalPERS to have the assets of the LLC appraised 120 days after the manager’s notice of intent to resign. CalPERS used one of its approved appraisers to do an appraisal and persuaded the appraiser to make certain adjustments to its original calculation before the report was issued and sent to the manager. When the manager objected to the appraisal, CalPERS triggered the LLC agreement’s appraisal arbitration process and ordered new appraisals from another appraiser, again pressuring the appraiser to deliver very low values. When the second appraisal was more than 5% lower than the first, CalPERS ordered a third set of appraisals from another appraiser, whom it also pressured to deliver a low value. Both sides agreed that the appraisal arbitration process was not used correctly, and at trial CalPERS abandoned its attempt to rely on the contractual appraisal process and argued under a new theory that the LLC had no equity and that nothing was owed for the membership interests. CalPERS later argued yet another theory for valuing the membership interests, but the court stated that the appraisers’ determinations could only be modified if there had been a breach of the implied covenant of good faith and fair dealing. The court focused on the original appraisal by the first appraiser and concluded that the pressure that CalPERS applied on the appraiser to make adjustments was a violation of the implied covenant of good faith and fair dealing. Thus, the court reinstated the original appraisal as it was calculated before the adjustments resulting from CalPERS’ improper pressure. The parties also disagreed on the date on which the payment for the membership interests would be calculated. The LLC agreement provided that upon a withdrawal, the “date of valuation for determining the purchase price of” the membership interests would be 120 days after the date of the manager’s notice of intent to withdraw. CalPERS argued that this provision referred only to the appraisal, which was only a part of the total calculation. (The appraisal determined the value of facilities invested in by the LLC but did not include the LLC’s financial assets.) The court found that the term “valuation” was used broadly to cover all kinds of assets; if the parties intended to refer only to the appraisal, they could have used the word “appraisal” as they did in other portions of the LLC agreement. With regard to asset management fees, CalPERS claimed that the manager erroneously included leasehold interests in its calculation of these fees. The management fees were a percentage of the fair market value of the facilities in which the LLC invested. The LLC agreement was silent on whether leasehold interests should be included, and the court thus looked to extrinsic evidence to determine the parties’ intent in this regard. The court stated that the best extrinsic evidence was what the parties actually did. For five years, CalPERS paid the manager asset management fees based on fair market value that included the leasehold interest, and a representative of CalPERS specifically approved of the calculation of the fees. Thus, the court refused to deviate from the established course of dealing of the parties. With regard to severance compensation that was due to the manager under the literal terms of management agreements with the manager, CalPERS argued that the management agreements should be reformed based on the doctrines of mutual or unilateral mistake to provide that the manager was not due severance compensation where it chose to resign as the LLC manager. Although the court characterized CalPERS’ argument as having “equitable force,” the court rejected CalPERS’ argument because CalPERS failed to meet its heavy burden of showing by clear and convincing evidence that the parties had a specific prior understanding that differed materially from the written agreement. The court ruled against CalPERS on all of its counterclaims, including breach of fiduciary claims asserted by CalPERS against the manager. The court stated that the breach of fiduciary duty claims arose out of the same facts as alleged breach of contract claims against the manager. The court pointed out that the Delaware Supreme Court has held that a dispute will be treated as a breach of contract claim where it arises from obligations that are expressly addressed by contract, and any fiduciary claims arising out of the same facts that underlie the contract obligations are foreclosed as superfluous.
68 A.3d 665 (Del. 2013)
ASB Capital Management, LLC and pension funds advised by it (collectively, “ASB”) entered into five joint ventures with The Scion Group, LLC (“Scion”) for the ownership, operation, and development of student housing. The parties created a special purpose Delaware LLC for each project. ASB provided at least 99% of the capital and retained at least 99% of the equity of each joint venture, and Scion was the sponsor and invested no more than 1%. Scion was primarily compensated through an incentive payment known as a “promote.” The LLC agreement for the parties’ first venture contained a standard capital-event waterfall provision with a 20% promote provision. Then the parties discussed structuring their deals with lower fees but a higher promote, and the parties eventually agreed in an email exchange to the terms of a two-tier promote for future deals. The first time the two-tier promote provision was placed in an LLC agreement between the parties, the first promote was placed after the first preferred return but before the return of capital, thus providing that ASB would begin to earn the promote before the parties received back their capital. The parties executed several more LLC agreements based on this form. When the mistake was discovered, ASB sought to reform all of the agreements to conform the two-tier promote provision to the terms set forth in the email. The chancery court reformed the agreements under the doctrine of unilateral mistake. The chancery court also awarded ASB attorneys’ fees based on a fee-shifting provision in the LLC agreements. The Delaware Supreme Court upheld the chancery court’s reformation of the LLC agreements even though a senior individual at ASB failed to read the agreements. The court recognized that there was a lack of clarity in the case law and resolved the confusion by relying on the Restatement (Second) of Contracts, which provides that “[a] mistaken party’s fault in failing to know or discover the facts before making the contract” does not bar a reformation claim “unless his fault amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing.” The court overruled prior Delaware case law to the extent it was inconsistent with this standard but noted that the standard is limited to reformation claims and does not apply to avoidance or rescission cases. The failure to read the agreements did not bar ASB from seeking reformation of the agreements because the record supported the chancery court’s finding that the senior individual at ASB read the first agreement and then relied on employees and advisors to alert him of significant changes in subsequent agreements. The court said these actions were in good faith and in accordance with reasonable standards of fair dealing. The court rejected Scion’s argument that the chancery court erred in granting reformation based only on “knowing silence.” The court recognized that the Delaware case law was contradictory as to whether reformation is available at all based on unilateral mistake or whether it is available, but only in “exceptional” cases. The record was clear that Scion did not engage in any fraud or trickery, but the court held that reformation based on a unilateral mistake is available where a party can show that it was mistaken and the other party knew of the mistake but remained silent. The court overruled prior cases to the extent they stated otherwise or imposed additional requirements. The court also held that the court of chancery accurately stated Delaware law when the court held that ratification of a contract subject to reformation requires actual knowledge of the mistake and that imputed or constructive knowledge is not sufficient. The court reversed the chancery court’s fee award based on the fee-shifting provision in the LLC agreements and remanded for the chancery court to determine whether to exercise its equitable authority to award fees. The fee-shifting provision in the LLC agreements required the non-prevailing party to reimburse the prevailing party for reasonable costs and expenses incurred in an action to enforce the agreement. The court discussed the plain meaning of the words “incurred” and “reimburse” and concluded the terms of the provision did not extend to the situation at hand because DLA Piper agreed to represent ASB without charge. Because ASB did not “incur” liability for attorneys’ fees and had no expense for which it needed to be “reimbursed,” it was not entitled to fees under the fee-shifting provision. ASB argued in the alternative that it was entitled to fees under a Delaware statute providing for the chancery court to award costs. The court stated that the case law improperly conflates a chancery court’s inherent equitable power to award fees with the authority provided in the statute. The court clarified that “costs” in the context of the Delaware statute is a term of art that does not include attorneys’ fees, and the court overruled any prior inconsistent cases. However, the court recognized the chancery court’s equitable power to shift attorneys’ fees, and the court remanded the case for the chancery court to consider whether to do so.
C.A. No. 7845-ML, 2013 WL 1934563 (Del. Ch. May 7, 2013)
Imbert sought advancement from two LLCs of fees and expenses he was incurring in his defense of a New York lawsuit filed against him by the LLCs after he was terminated from his position as manager of the LLCs. The LLC agreements required tax distributions to the members, and the LLCs alleged that Imbert had been inflating his tax liability so that he would receive disproportionately large distributions. In the New York lawsuit, the LLCs alleged that Imbert breached fiduciary duties owed as a manger and committed fraud when he approved and accepted the allegedly improper distributions, that Imbert was unjustly enriched by retaining the allegedly improper distributions, and that Imbert improperly charged personal expenses to a business expense account. The LLCs also sought in the New York action a declaratory judgment as to whether Imbert was still a member of the LLCs. The LLC agreements provided that each LLC “shall indemnify” any person “made, or threatened to be made, a party to any action or proceeding .... by reason of the fact that he ... is or was a Manager, or an officer of the Company ...” and that the LLC must advance or promptly reimburse “[a]ll expenses reasonably incurred by an Indemnified Person in connection with a threatened or actual action or proceeding with respect to which such Person is or may be entitled to indemnification ....” Because advancement and indemnification were mandatory under the LLC agreements, the burden was on the LLCs to prove that advancement was not required. The LLCs argued that Imbert was not entitled to advancement because the claims in the New York litigation involved wrongdoing by Imbert as a member and not as a manager. In focusing on whether the claims in the New York action arose “by reason of the fact” that Imbert was a manager of the LLCs, the court relied on Delaware case law stating that a proceeding is “by reason of the fact” that one is a corporate officer if there is a nexus or causal connection between any of the underlying proceedings and one’s official capacity. The nexus is established if the “corporate powers were used or necessary for the commission of the alleged misconduct,” which includes all actions brought against an officer or director “for wrongdoing that he committed in his official capacity” and all misconduct allegedly occurring “in the ordinary course of performing his day-to-day managerial duties.” The court found that the LLCs’ breach of fiduciary duty and fraud claims against Imbert related to acts in his capacity as a manager rather than as a member and that the nexus was thus sufficiently established as to those claims. The breach of fiduciary duty claim rested on Imbert’s capacity as a manager because the LLC agreement did not impose fiduciary duties on members, and Delaware law imposes no default fiduciary duties on non-managing, non-controlling members. As in the case of the breach of fiduciary duty claim, the fraud claim depended on Imbert’s role as a manager because the LLC agreement imposed no obligation on a member to make disclosures, and simply receiving distributions as a member without revealing that he had received tax refunds for the years at issue involved no deception. With respect to the LLCs’ unjust enrichment claim, however, the court concluded that Imbert was not entitled to advancement of fees. Retaining, as a member, the allegedly improper distribution, as alleged in the unjust enrichment claim, did not arise by “reason of the fact” that Imbert was a manager of the LLCs. The business expense claim had been dismissed from the New York case in anticipation of submission to mandatory arbitration, but the court addressed Imbert’s right to advancement in connection with this claim as well as the others. The court concluded that Imbert was entitled to advancement in connection with this dispute because it was rooted in the misuse of responsibility and trust given to Imbert as CEO of a subsidiary limited partnership of the LLCs, and the LLC agreements covered those who served at the request of the LLCs as an officer of any other enterprise. Further, the LLCs’ agreement that the claim should be withdrawn in favor of mandatory arbitration before FINRA confirmed that the claim related to Imbert’s role as CEO of the affiliate because a claim between the LLCs and a member of the LLCs would not be subject to mandatory arbitration before FINRA. The court concluded that Imbert was also entitled to advancement of fees in connection with the declaratory judgment sought by the LLCs in the New York action. The LLCs sought declaratory judgment that Imbert was not a member of the LLCs, which was a determination that depended on whether Imbert was properly removed as a manager because only a non-manager member could be expelled. Finally, the court granted Imbert’s claim for advancement of fees incurred in a books and records request. The LLCs claimed this right belonged to Imbert by virtue of being a member because he invoked his statutory right as a member (as he was no longer a manager at the time he made his request) under the Delaware LLC statute. However, the court concluded that he exercised the right in order to defend claims asserted against him as a manager, and the court stated that certain offensive actions such as his books and records action can be a legitimate part of “defending” a suit. The court granted Imbert an award of “fees on fees” to the extent the court granted Imbert’s contractual right to advancement.
C.A. No. 6920-VCG, 2013 WL 1821621 (Del. Ch. May 1, 2013)
The liquidating trustee of an LLC law firm filed this action because one of the two members of the firm disputed the liquidating trustee’s authority to disburse fees received from the settlement of a case. After the firm’s two members, Conaty and Curran, entered into a liquidation agreement to dissolve and wind up the firm’s business, the members appointed a liquidating trustee to manage the dissolution. Conaty asserted that he did substantial post-dissolution work on a case against the Catholic Diocese of Wilmington resulting in a settlement that gave rise to a substantial fee. Initially, Conaty disputed whether the fee was a firm asset, but he ultimately conceded that point, and the remaining issue was whether the liquidating trustee’s decision to distribute the fee 50-50 to Conaty and Curran was consistent with the trustee’s obligations under the liquidation agreement. The court concluded that the liquidating trustee’s decision to distribute the fee equally to Curran and Conaty was consistent with the liquidation agreement. The liquidation agreement granted the liquidating trustee “sole authority” to act on behalf of the firm in winding up and distributing its assets, and the agreement specified that the firm must be wound up and its assets distributed in accordance with Section 18-804 of the Delaware Limited Liability Company Act. Under Section 18-804, an LLC that is winding up must first pay creditors, next return members’ capital contributions, and then distribute remaining assets in the proportion in which members share in distributions. Contay argued that the liquidating trustee must apply the doctrine of quantum meruit to compensate the members for work performed in the winding up, citing cases applying quantum meruit to allocate contingent fees to partners of dissolved firms. The court found these cases to be inapposite because they dealt with foreign partnerships rather than Delaware LLCs, and they generally involved the question of whether fees from legal services rendered after a law firm’s dissolution constituted assets of the defunct firm or belonged to the attorney who performed the work. Conaty conceded that the fee at issue belonged to the firm, and the court said the cases he cited were irrelevant to the question of how the liquidating trustee should apportion the fee under the liquidation agreement. The liquidation agreement specified that the trustee should distribute assets in accordance with Section 18-804, and Section 18-804 required distribution in proportion to the members’ interests in the firm. Conaty did not dispute that he and Curran shared the firm’s profits 50-50 in accordance with the operating agreement. Thus, the liquidating trustee’s decision to distribute firm assets in this proportion was consistent with the plain language of the liquidation agreement. The court rejected an argument by Conaty that the members were creditors of the firm by virtue of their post-dissolution winding-up services and that they should be compensated for their work before making final membership distributions. Conaty again relied on quantum meruit principles, but that doctrine applies only where there is no governing contract. Here, the liquidation agreement gave the trustee authority to manage the firm’s affairs and make distributions. A decision to compensate the members based on an equal division of profits, rather than based on hourly work, is the kind of decision that would ordinarily lie with the firm’s members and which the members decided in the operating agreement was their preferred method of compensation. Because the members agreed to vest the liquidating trustee with authority to manage all aspects of the firm’s operations in order to wind up the firm, application of quantum meruit was inappropriate, and the court approved of the liquidating trustee’s distribution of the fee in proportion to their equal membership interests.
C.A. No. 8191-VCN, 2013 WL 1286202 (Del. Ch. March 28, 2013)
Li sought advancement of legal fees pursuant to an indemnification agreement between Li and an LLC after the LLC’s controlling owners initiated an arbitration proceeding against Li for breach of fiduciary duties to the LLC. When the LLC failed to satisfy Li’s demand for advancement, he brought this action to enforce his advancement rights, and the LLC sought to dismiss or stay the action in favor of arbitration. The indemnification agreement did not contain an arbitration provision but contained an integration clause and provided that the question of Li’s right to indemnification “shall be for an arbitrator or court to decide” if the LLC contested Li’s right. Several other agreements to which Li and the LLC were parties contained mandatory arbitration clauses and integration clauses. Li was the founder of the LLC’s predecessor and became a 25% owner of the LLC when the predecessor’s assets were sold to the LLC under an asset purchase agreement that contained a broad arbitration clause and an integration clause. The LLC agreement also contained an arbitration clause and an integration clause, as did Li’s employment agreement with the LLC. The court applied the standard established in Willie Gary LLC v. James & Jackson LLC, under which the question of arbitrability is presumed to be a question for the court rather than arbitrators unless there is “clear and unmistakable” evidence that the parties agreed to arbitrate. Willie Gary held that such evidence is present if the arbitration clause either generally provides for arbitration of all disputes or incorporates a set of arbitration rules that empowers arbitrators to decide arbitrability. The Willie Gary “clear and unmistakable” test has been modified by subsequent case law in one respect. Even if the Willie Gary test is met, a court must still “make a preliminary evaluation of whether the party seeking to avoid arbitration of arbitrability has made a clear showing that its adversary has made essentially no non-frivolous argument about substantive arbitrability.” The court here concluded, and Li did not dispute, that the asset purchase agreement, LLC agreement, and employment agreement satisfied the two prongs of the Willie Gary test because the broad arbitration clauses in those agreements generally provided for arbitration of all disputes and referenced the rules of Judicial Arbitration and Mediation Services. However, Li argued that the Willie Gary test should only apply to the indemnification agreement because it was executed after the other agreements and contained an integration clause showing that the parties intended the agreement to be the entire agreement with respect to its subject matter. The court acknowledged that the integration clause was some evidence that the indemnification agreement was completely independent of the other agreements and might lead to the conclusion that the arbitration provisions in the prior agreements were nullified with respect to the matter of advancement and indemnification. However, in the context of the limited inquiry permitted under Willie Gary and its progeny, Li’s integration argument fell short because the integration clause did not conclusively establish that the valid arbitration clauses in the prior agreements were terminated. Some cases have held that a standard integration clause in a later agreement with no arbitration clause does not overcome an earlier agreement with an arbitration clause. Li also relied on the provision of the indemnification agreement granting the parties the right to litigate in Delaware courts under certain circumstances. The court stated that by focusing solely on the indemnification agreement, Li was subtly asserting that the claims asserted in his complaint did not relate to the prior agreements. However, who decides the question of substantive arbitrability turned on whether Li could clearly show that the LLC had made no non-frivolous argument that the dispute relates to the asset purchase agreement, LLC agreement, or employment agreement. Although Li’s claims were based solely on the indemnification agreement, he arguably could not have brought them absent the other prior agreements that made him a member and officer of the LLC. The LLC’s advancement and indemnification obligations arguably would not have arisen absent the parties’ execution of the prior agreements, and the indemnification agreement could even be viewed as supplementing various provisions of the LLC and employment agreements. Further, Li’s claims for indemnification at least colorably related to the LLC agreement in that he sought adjudication of substantive rights that were also provided in the LLC agreement. Although these arguments might not be very persuasive, they met the low threshold the court was required to apply, and the court could not conclude that the LLC had no non-frivolous arguments in favor of arbitrability. Thus, the court granted the LLC’s request to stay the action pending an arbitrator’s determination of arbitrability.
C.A. No. 7801-VCN, 2013 WL 1286180 (Del. Ch. March 28, 2013)
The plaintiffs, former employees of the defendant LLCs and Class B members of defendant DFW Midstream Management, LLC (“Management”), asserted various claims against Management, DFW Midstream Services LLC (“Services”), Summit Midstream Partners, LLC (“Summit”), and Summit Midstream Holdings, LLC (“Summit Holdings”). The members of Services were Management, Summit, and Texas Competitive Electric Holdings Company, LLC (“TCEH”) until 2010, when Summit purchased all of TCEH’s membership interest in Services. In 2011, the defendants entered into a Second Amended and Restated Limited Liability Company Agreement of Services (the “2011 Amendment”), and Summit transferred its membership in Services to Summit Holdings. The sole manager of Management was Summit. The plaintiffs asserted that the changes effected by the 2011 Amendment were invalid without their consent. The plaintiffs brought several claims in connection with the 2011 Amendment. The court dismissed each of the plaintiffs’ claims. The plaintiffs sought a declaratory judgment that the 2011 Amendment was invalid and a breach of the Services LLC agreement in effect before the amendment (the “2009 Services LLC Agreement”). The plaintiffs argued that the defendants breached the 2009 Services LLC Agreement by amending the agreement in a way that materially affected the plaintiffs’ interests without their consent. The 2009 Services LLC Agreement provided that no amendment, modification, or supplement to the agreement could adversely affect the interest of a member without that member’s consent, but the plaintiffs were never members of Services. Thus, the court held that the plaintiffs did not plead a reasonably conceivable claim of breach of contract. The court determined that the plaintiffs failed to adequately allege that various actions taken by the defendants violated the 2009 Services LLC Agreement or the 2011 Amendment, but the plaintiffs argued that even if the defendants’ actions were technically permissible under those agreements, the defendants violated the implied covenant of good faith and fair dealing by repeatedly acting in bad faith to keep the plaintiffs from receiving the fruit of their bargain under the 2009 Services LLC Agreement, the Management LLC agreement, and award agreements entered into between the plaintiffs and Services and Management. The defendants conceded that elimination of language regarding the duty of good faith and fair dealing from the 2009 Services LLC Agreement had no legal effect because Delaware law prohibits LLCs from eliminating this duty, but the defendants argued that the plaintiffs failed to state a claim for breach of the implied covenant. To state a claim for breach of the implied covenant, a plaintiff must allege a specific implied contractual obligation and how the violation of that obligation denied the plaintiff the fruit of the contract. The court rejected the plaintiffs’ argument that the defendants needed plaintiffs’ consent in order to amend the 2009 Services LLC Agreement in a way that essentially eliminated future payment for the plaintiffs because the 2009 Services LLC Agreement expressly set out an amendment process that did not require the plaintiffs’ consent as non-members. Thus, an implied covenant was not appropriate. The plaintiffs’ alternative formulation of the implied covenant was that the clear purpose of the parties’ bargain was that the plaintiffs would receive a share of the profits in exchange for the plaintiffs’ continued services after the defendants received their return of capital. This argument failed because the plaintiffs did not allege that this commitment was breached. The plaintiffs retained their rights to a share of the profits of Services as paid through Management. The plaintiffs took only an indirect interest in profits and did not acquire any corporate governance authority over Services. Though the plaintiffs may have been disappointed with what Summit, as manager of Services, did, the plaintiffs did not show that Summit acted outside of the business structure and management discretion to which they agreed. The court next rejected the plaintiffs’ claim that Summit and Summit Holdings breached their fiduciary duties under the 2009 Services LLC Agreement because the plaintiffs were not members of Services and thus were not owed any fiduciary duties under the agreement. Further, the agreement unambiguously eliminated fiduciary duties of the managers. The plaintiffs’ claim for breach of fiduciary duties under Management’s LLC agreement also failed because the agreement specifically eliminated any fiduciary duties of Summit. The plaintiffs’ fraud claim against the defendants was based on the theories of “active concealment” and “duty to speak.” The plaintiffs argued that the defendants committed fraud by failing to inform plaintiffs of the 2011 Amendment and of the full scope and character of certain credit facilities and resulting encumbrances on Services. The “duty to speak” theory did not apply because the plaintiffs were not members of Services, and their consent to the 2011 Amendment was not required. Thus, the defendants did not have a duty to disclose the existence of the 2011 Amendment or the credit facilities to the plaintiffs. The “active concealment” theory did not apply because it requires more than mere silence under Delaware law. The plaintiffs claimed that active concealment took place because one of the plaintiffs sought a copy of the 2011 Amendment but was denied it, and another plaintiff asked but received no answer to the question of whether there had been any amendments to the 2009 Services LLC Agreement. However, the plaintiffs’ lack of knowledge of the 2011 Amendment could not have been relied upon to their detriment because they could not challenge the adoption of the amendment. Finally, the plaintiffs sought judicial dissolution of Services and Management under Sections 18-802 and 18-803 of the Delaware Limited Liability Company Act. Because the plaintiffs were not members or managers of Services, they could not apply for dissolution of Services under the statutory provisions on which they relied. With respect to the plaintiffs’ claim for judicial dissolution of Management, the court looked to circumstances under which dissolution has been ordered under the analogous limited partnership dissolution statute. These circumstances are (1) where there is a “deadlock” that prevents the entity from operating, and (2) where the defined purpose of the entity is fulfilled or impossible to carry out. The plaintiffs did not allege deadlock with respect to Management, and their disagreement with the credit facility entered into by the defendants and the initial public offering of Summit Holdings did not plead a reasonably conceivable claim that it was no longer reasonably practicable for Management to carry on in accordance with its LLC agreement because Management’s LLC agreement contained a broad purpose clause allowing Management to engage in any lawful act or activity for which LLCs may be organized under the Delaware Limited Liability Company Act.
C.A. No. 4113-VCN, 2013 WL 764688 (Del. Ch. Feb. 28, 2013)
The plaintiffs complained of an LLC’s failure to repurchase the plaintiffs’ units when the plaintiffs were terminated and the LLC’s adoption of a conversion and exchange agreement that involved a capital restructuring of the LLC. The plaintiffs alleged that the capital restructuring adversely affected the value of the plaintiffs’ holdings because the defendants diverted the LLC’s assets for their benefit. The court granted the defendants’ motion for summary judgment on the breach of contract claims stemming from the failure to repurchase their units as well as breach of fiduciary duty claims against Rayevich, a member of the LLC’s managing board, and Sheridan, the LLC’s Chief Financial Officer, in connection with their alleged involvement with the LLC’s adoption of the conversion and exchange agreement, but civil conspiracy claims against some of the defendants survived summary judgment. The breach of contract claims and civil conspiracy claims were governed by New Jersey law, but the breach of fiduciary duty claims were governed by Delaware law. The plaintiffs alleged that the LLC breached unit holder agreements with the plaintiffs by failing to repurchase their units when the plaintiffs were terminated. The agreements, which the parties agreed were governed by New Jersey law, provided that the LLC “may” purchase some or all of the units upon termination of an investor. The court stated that the use of the word “may” denoted a permissive standard and imposed no express duty to repurchase the plaintiffs’ units. There is an implied covenant of good faith and fair dealing in every contract under New Jersey law, and the implied covenant may be breached where a party exercises its discretion under a contract with a dishonest purpose or intent to profit at the expense of another in violation of the spirit of the contract. The plaintiffs claimed that they expected their units to be acquired by the LLC if they were terminated, but their expectation was not incorporated into the contract, and the plaintiffs offered nothing to support their “reasonable expectation” when they entered into the contract in 2001 that they could force the LLC to purchase their units in the event they were terminated. The court recognized that the implied covenant might have required the LLC to act in good faith when it decided whether or not to purchase the units. The court could understand why the plaintiffs would not want to be minority unit holders in the enterprise, but the court found it hard to see why this would be an “inequitable” result. The plaintiffs pointed to another former employee whose units were purchased after termination, but the plaintiffs offered no cohesive theory to explain why the differential treatment was somehow proof that the implied covenant should be given effect. The LLC was entitled to summary judgment on this claim, and defendants against whom the plaintiffs asserted claims for tortious interference with the unit holder agreements were also entitled to summary judgment since the LLC did not breach the agreements. The LLC agreement required Rayevich, as a member of the LLC’s managing board, to manage the LLC reasonably and in good faith, and the agreement exculpated him from liability absent willful misconduct or bad faith. Although Rayevich was a member of the LLC’s managing board, he had no discretion in how to vote because he was required to vote as directed by another individual. Although Rayevich had no discretionary voting power, the court stated that his fiduciary duties extended beyond voting and could involve studying the proposed transaction, determining its appropriateness, expressing dissenting views to fellow board members and, under proper circumstances, informing unit holders about potential adverse effects. Plaintiffs failed, however, to allege any facts that demonstrated Rayevich’s conduct was willful or in bad faith in connection with the conversion and exchange agreement, and he was entitled to summary judgment. Sheridan, the CFO of the LLC, did not dispute that she owed fiduciary duties to the plaintiffs. The plaintiffs alleged various acts of wrongdoing related to the conversion and exchange agreement. The court extended to the LLC context the principle that corporate fiduciaries may breach their general fiduciary duty to shareholders if the fiduciaries make misleading disclosures even though the disclosures do not relate to a specific request for shareholder action. When no shareholder or unit holder action is sought, the plaintiff must prove that the fiduciary knowingly disseminated materially false information and must prove reasonable reliance, causation, and damages. Here, the court concluded that the plaintiffs failed to demonstrate that Sheridan’s alleged statements caused them any damage or that they relied on any of her alleged misrepresentations. Thus, the court granted summary judgment in her favor on this claim. The court also addressed claims of civil conspiracy under New Jersey law. The plaintiffs alleged that individual and entity defendants engaged in a civil conspiracy to harm the plaintiffs by depriving them of their Class A units pursuant to the restructuring under the conversion and exchange agreement. The defendants primarily challenged the sufficiency of the element of an agreement. Some of the alleged conspirators were equity holders, and some were debt holders. Some of the parties to the conversion and exchange agreement agreed to its terms, and the court posed the question whether that sort of written confirmation of a business transaction satisfies the agreement element for a conspiracy. The court concluded that there was a disputed issue of material fact as to whether the defendants other than Rayevich and Sheridan reached an agreement to pursue the conversion and exchange agreement and thus, according to the plaintiffs, to harm the plaintiffs for the benefit of the defendants. The court granted summary judgment in favor of Rayevich on the civil conspiracy claim because the plaintiffs identified no overt action on his part. The court concluded that Sheridan’s actions leading up to the conversion and exchange agreement could support a reasonable inference that she agreed to the alleged purpose of the agreement (i.e., to inflict a wrong on the plaintiffs), and the court thus concluded that summary judgment in her favor on the conspiracy claim was precluded.
62 A.3d 676 (Del. Ch. 2013)
This post-trial opinion addressed claims of a minority unitholder who owned common units in a privately held medical device LLC. The plaintiff sued the directors and certain venture capital investors for breach of the duty of loyalty in connection with a financing transaction involving the issuance of additional preferred units and creation and issuance of new series of preferred units without approval of the common unitholders. With respect to the claim against the investors, the plaintiff was required to show that they acted in concert so as to constitute a controlling group because neither investor alone possessed voting or actual control. The plaintiff was not able to show that the two investors acted in concert to exert control, and the plaintiff’s claim against them thus failed. Turning to the breach of duty claim against the directors, the court determined that the LLC agreement defined the scope of the directors’ duties by setting a general standard for fiduciary conduct and by giving the directors the right to engaged in conflict-of-interest transactions subject to certain requirements. The court concluded that the LLC agreement effectively established an entire fairness standard by providing that directors could enter into conflicted transactions if the payments made by the LLC were comparable to payments that would be paid to unrelated third parties for the same property, goods, or services. The provision also specified that a conflicted transaction would not be deemed void or voidable if it was fair to the LLC at the time it was authorized. The court next addressed who had the burden of proof with respect to the entire fairness standard. Recognizing that the directors of a corporation or fiduciaries owing default fiduciary duties in the LLC context bear the burden of establishing the fairness of a conflicted transaction, the court focused on the contractual duties in this case and determined that the plaintiff bore the burden of establishing a breach of the agreement by showing a conflicted transaction was not entirely fair. The court discussed the fact that other provisions of the agreement deemed a conflicted transaction not to be void or voidable if certain safe harbors (borrowed from the corporate interested director statute) were met, and the court acknowledged that it was unclear whether compliance with a safe harbor provision would trigger review under the business judgment rule or shift the burden to the party challenging the transaction. The court determined that placing the burden on the plaintiff to prove that the transaction was not fair harmonized the provisions of the agreement because placing the burden on the directors would make the safe harbor for fairness at the time the transaction was authorized redundant. The court distinguished the provision in this case from the provision at issue in the Gatz case, where the provision prohibited conflicted transactions on terms less favorable than arm’s-length transactions without the required consent. In that case, the Delaware Supreme Court held the burden of proving entire fairness was on the defendants. In this case, rather than being phrased as a prohibition, the provision at issue affirmatively authorized conflicted transactions on terms no less favorable than comparable unrelated party transactions. Here, the transaction was approved in accordance with one of the safe harbors, i.e., good faith approval by disinterested directors. Thus, the court concluded that the directors should arguably be protected by the business judgment rule, or the burden on entire fairness should shift to the plaintiff if the plaintiff did not already have the burden. In any event, the court stated that the evidence was sufficiently strong that the directors prevailed on the fairness issue whichever party had the burden. At the time of the transactions, the LLC needed money to continue its business and had sought financing from various sources. The LLC had limited funding options because it was a risky investment. The defendants’ expert opined convincingly that the transactions were fair, and the plaintiff’s expert made troubling errors in her report. The court thus concluded that the plaintiff did not prove the transactions were less than entirely fair, and the defendants established that the transactions were entirely fair if they bore the burden. The court also determined that the defendants were not required to reimburse the LLC for legal fees advanced to them. The directors were entitled to indemnification under the LLC agreement. Further, although advancement was not specifically authorized, the court concluded that authority to advance the defendants’ legal fees was included in the broad authority to make all decisions granted by the LLC agreement. The central question in the breach of contract claim was whether the LLC agreement required approval of common unitholders to increase the number of units the LLC was authorized to issue and to create additional classes or series of units. The court examined the language of the LLC agreement, which used three terms from the corporate context: “create,” “authorize,” and “issue.” The agreement required common unitholder approval for all amendments other than the “issuance” of additional units under provisions that authorized the board to “create” and “issue” units. The defendants argued that the power to increase the number of authorized units was incidental to the power to create and issue units under the agreement and to unilaterally amend the agreement in these transactions. The court disagreed, relying in part on testimony of the attorney who drafted the agreement. The court noted that the agreement only gave the board power to create and issue units, while the agreement was silent on the steps necessary to authorize additional units and gave certain unitholders veto rights in connection with the authorization of units. The court concluded that the most reasonable interpretation of the agreement was that the parties intended the agreement to be amended in order to authorize units. Reading the agreement as a whole, the court concluded that it clearly did not authorize additional units without obtaining the unitholder consent required by the amendment provisions regardless of whether the board could unilaterally create or issue additional units. The court next rejected the plaintiff’s argument that common unitholder approval was required to create additional series or classes of units. The plaintiff argued that the exception to the amendment provision referred only to “issuance” of units although it cross-referenced a provision that authorized the directors to “create” additional units. The court found the provision was ambiguous and considered extrinsic evidence, including the drafting history of the agreement and an amendment of the provision cross-referenced in the amendment provision. The circumstances of the amendment indicated that it was intended as a clarification that the board was authorized to “create” and “issue” additional units. The court concluded that the language referring to the “issuance” of units in the amendment provision was not limiting language but broadly referred to the subject matter of the cross-referenced provision, which included the creation and issuance of additional classes or series. Because the LLC agreement required common unitholder approval to increase the authorized units, the directors breached the agreement by increasing the number of authorized units without the requisite approval and issuing units that had been created in accordance with the agreement but had not been properly authorized. The court rejected the defendants’ strained argument regarding the meaning of the familiar corporate term “authorize,” which was used imprecisely in the agreement. The court additionally found that this was a case where it was appropriate to construe ambiguous terms against the drafter. It was reasonable for the common member to understand the term “authorize” in the agreement to place a limit on the dilution he could be subjected to without his consent. With respect to the appropriate remedy for the breach of contract, the court concluded that reformation of the transaction was not warranted and that there were no damages suffered. The challenged transaction provided the LLC with crucial capital on fair terms. The dilution suffered by the plaintiff was in return for maintaining some value in his investment. Thus, the court awarded only nominal damages of $1.
C.A. No. 5725-VCP, 2013 WL 297950 (Del. Ch. Jan. 25, 2013)
In this action that resulted from the consolidation of two cases, the plaintiff, one of two members of a technology joint-venture LLC, alleged that the other member, Silverback Media, PLC (“Silverback”), breached the LLC agreement and breached its fiduciary duty to the plaintiff and the LLC by usurping corporate opportunities belonging to the LLC. Silberback sought judicial dissolution of the LLC. The court first addressed the plaintiff’s claim that Silverback breached the LLC agreement by providing interactive advertising content through mobile platforms independently of the LLC. Silverback argued that its actions did not violate the LLC agreement, but the court rejected Silverback’s interpretation of the agreement and concluded that its conduct breached the agreement. In the LLC agreement, the members agreed that the LLC and its subsidiaries would be the only means through which the members and their affiliates would conduct the “Business.” Another section of the LLC agreement stated that the purpose of the LLC was “to license, develop and own and market technology, content and applications for the purpose of enabling and enhancing interactive video programming and advertising content,” and the agreement provided that the conduct of these activities in North America would be deemed the “Business.” Silverback argued that the phrase “interactive video” modified both “programming” and “advertising content,” and the plaintiff argued that the word “interactive” modified “video programming” and “advertising content,” i.e., that the scope of the Business included “interactive video programming” and “interactive advertising content.” Analyzing the language in the context of other provisions of the agreement, the court concluded the language was unambiguous and agreed with the plaintiff as to its meaning. Further, the court stated that if it were to consider the extrinsic evidence, it would still construe the words at issue in favor of the plaintiff. The court next addressed the plaintiff’s claims that Silverback breached the LLC agreement and its fiduciary duties by acquiring competing businesses without offering the LLC or the plaintiff an opportunity to invest in these other businesses. The LLC agreement stated that the members were “fiduciaries to each other and the Company” and required the parties to act in the best interest of the LLC and to exercise the utmost good faith and fair dealing. The court stated that Delaware common law also requires parties to a joint venture to act with the utmost good faith, fairness, and honesty with each other with respect to the enterprise. The court found that certain of the alleged opportunities were within the LLC’s line of business and that the LLC had an interest or expectancy in those opportunities. Silverback alleged that the LLC did not have the financial ability to exploit the opportunities, but the court disagreed. In any event, based on corporate precedent, the court held that there is no need to consider the financial ability of the LLC to exploit the opportunities in a corporate opportunity analysis where there is a parallel contractual obligation to present corporate opportunities. The court also concluded that Silverback stood in a position inimicable to its duties to the LLC as a result of the alleged usurpation. The court thus concluded that the elements of the corporate opportunity test were satisfied with respect to opportunities taken by Silverback and held that Silverback breached its fiduciary duties. After the plaintiff sued Silverback, a Canadian company acquired all of the assets of Silverback in consideration solely for a deed of indemnity by the Canadian company to pay all claims of Silverback’s creditors in Silverback’s liquidation. The plaintiff alleged that such transfer constituted a fraudulent transfer because the transfer was made with actual intent to hinder the plaintiff’s ability to enforce his rights under the LLC agreement. The Canadian company argued that the court had no personal jurisdiction over it. The court found that it had personal jurisdiction over the Canadian company under the Delaware long-arm statute because the company “purposely availed” itself of the benefits and protections of Delaware by incorporating Delaware subsidiaries for the purpose of acquiring the entities that formed the basis of Silverback’s wrongful usurpation of the LLC’s corporate opportunities. The court also concluded that the Canadian company was subject to personal jurisdiction under the implied consent provision of the Delaware Limited Liability Company Act because the Canadian company participated materially in the management of the LLC by causing Silverback to file a petition for judicial dissolution of the LLC in the Delaware Chancery Court. The court then held that the transfer by Silverback to the Canadian company constituted a fraudulent transfer. The court next addressed the petition for judicial dissolution of the LLC filed by the Canadian company on behalf of Silverback. The court stated that Delaware case law gives a court discretion, in the exercise of the court’s equitable powers, to decline a petition for judicial dissolution even though the statutory standard is met. The court determined that it might not be reasonably practicable to carry on the LLC’s business in this case, but the court refused to order judicial dissolution. The court concluded that the breaches of contract and fiduciary duties by Silverback contributed materially to the LLC’s inability to fulfill its business purpose, and the court concluded that Silverback should not be permitted to use its own inequitable conduct to extricate itself from the LLC. The court also found that a judicial dissolution might interfere with the plaintiff’s recovery of the damages to which he was entitled.
__ F.Supp.2d __, 2013 WL 2039307 (M.D. Fla. 2013)
The plaintiff, a company that engaged in payroll funding and accounts receivable factoring, entered into several Master Factoring Agreements with an LLC under which the plaintiff agreed to purchase and the LLC agreed to sell certain accounts receivable of the LLC. The plaintiff sued the LLC, the LLC’s president, and the LLC’s sole managing member for fraud and various other claims based on an alleged “ponzi-type” scheme whereby the defendants used the plaintiff’s money from new factored invoices to pay older invoices as they became due. The plaintiff also contended that the defendants wrongfully converted to their own use payments that the plaintiff deposited into the managing member’s personal bank account. The LLC and its president, who was responsible for the day-to-day management of the LLC, admitted that the undisputed evidence established that the plaintiff was entitled to summary judgment against them for liability for fraud, fraudulent inducement, violations of the Florida Deceptive and Unfair Trade Practices Act and Florida RICO, but the managing member argued that the summary judgment record did not support summary judgment against her based on either her personal involvement in the scheme or her role as managing member of the LLC. The court agreed with the managing member. The record contained no evidence of statements or misrepresentations by the managing member to the plaintiff or its agents and thus was insufficient to support summary judgment against the managing member based on her personal involvement in the fraudulent scheme. The plaintiff argued that the managing member was liable based on her role as managing and sole member of the LLC since she was the only individual entitled to share in the profits and losses of the LLC, the only individual with the right to receive distributions, and the only individual with voting and management rights. Under the Florida LLC statute, a member or manager does not have liability for a debt, obligation, or liability of the LLC solely by reason of being a member or serving as a manager or managing member, and a manager or managing member is not personally liable for monetary damages to the LLC, its members, or any other person for any statement, vote, decision, or failure to act regarding management or policy decisions unless the manager or managing member breached or failed to perform the duties as a manager or managing member and the breach resulted in a violation of criminal law or an improper personal benefit, or constituted recklessness or an act of bad faith. The court said that, at best, the record contained evidence sufficient to create an inference that the managing member breached one or more duties as managing member and that she knew or should have known that the LLC was engaged in criminal activity or that she acted with reckless indifference to the fraudulent scheme. Similarly, the record, at best, created an inference that the managing member derived a personal benefit since payments were deposited into her personal account. The evidence and inferences were insufficient, however, to establish the plaintiff’s entitlement to summary judgment against the managing member. There were also disputed issues of material fact as to whether the managing member was a debtor (based on a guaranty executed in favor of the plaintiff by the managing member) and intended to defraud the plaintiff with respect to the plaintiff’s fraudulent transfer claim against the managing member.
__ S.E.2d __, 2013 WL 2321982 (Ga. App. 2013)
The American Arbitration Association sued the members of an LLC to collect unpaid arbitration fees. The court of appeals held that there was evidence that the members asserted individual claims through arbitration and were liable for the arbitration fees. The court acknowledged that the Georgia LLC statute protects members from liability for the debts of the LLC solely by reason of being a member. Further, there was no evidence the members executed an agreement to guarantee the LLC’s debts. However, the court concluded there was evidence that the members incurred personal debts in the arbitration by stating in a trial brief that they and the LLC were submitting their claims to binding arbitration. The arbitrator testified that the members were parties to the arbitration in their personal capacities, and the evidence from the arbitration showed that the members appeared in their personal capacities. Thus, the members were personally liable for any fees associated with their personal claims.
740 S.E.2d 410 (Ga. App. 2013)
The LLC operating agreement of an LLC formed by two doctors contained a provision that gave each member, following the other member’s death, the option to purchase the deceased member’s interest in the LLC, and the purchase price was to be determined by the LLC’s certified public account. Dr. Davis died, and his wife, Lori Davis (“Davis”), was appointed the administrator of his estate. The remaining member and the LLC sued the estate to enforce the LLC operating agreement provision authorizing the CPA to determine the purchase price of the deceased member’s interest in the LLC. The trial court entered partial summary judgment in favor of the plaintiffs, and Davis appealed. On appeal, Davis first argued that the trial court’s summary judgment finding that the LLC’s CPA was authorized to determine the purchase price was erroneous. The appellate court disagreed with Davis. The evidence showed that the LLC’s operating agreement expressly provided that “the purchase price for the membership units shall be their fair market value as determined in a commercially reasonable manner by or under the CPA regularly representing the LLC, whose decision in this matter shall be conclusive.” The court stated that the intent of the parties to the operating agreement was clear and unambiguous in authorizing the LLC’s CPA to determine the purchase price, and the trial court did not err in its construction of that portion of the operating agreement. Davis’s challenge to the propriety of such a provision failed to recognize the contractual flexibility afforded members of an LLC and the state policy to give maximum effect to the principle of freedom of contract and enforceability of operating agreements. Next, Davis contended that the trial court erred in granting partial summary judgment in favor of the plaintiffs because the plaintiffs waived the enforcement of the provision in the operating agreement authorizing the CPA to determine the purchase price by first obtaining a valuation of the deceased member’s interest from another accounting firm. The court found that Davis showed no evidence of waiver of the provision at issue. The alternate valuation was performed solely for the purpose of assisting the plaintiffs in negotiating with Davis. Once the negotiations ended unsuccessfully, the plaintiffs’ complaint sought to enforce the operating agreement provision authorizing the CPA to conclusively determine the fair market value and purchase price. Davis next alleged that the provision in the LLC’s operating agreement authorizing the appraisal by the CPA required a mandatory arbitration. The court again disagreed with Davis and explained that this case involved a contract provision concerning the method of appraising value. Appraisal involves an issue of value and does not constitute a common law or statutory arbitration, which would be invoked to resolve broader issues of liability. The court found that the provision in question was an appraisal clause set forth only to resolve an issue of value and not broader issues of liability, so Davis’s claim that the provision was an arbitration clause was without merit. Finally, Davis argued partial summary judgment in favor of the plaintiffs was erroneous because a genuine issue of material fact existed as to fraud and whether the CPA determined the fair market value in a commercially reasonable manner. However, Davis failed to indicate what specific facts showed fraud or a lack of commercial reasonableness. Although the court stated that it had no duty to go through the record in search of support for the contentions of the parties, the court reviewed the pages cited by Davis and found no evidence of fraud or that the appraisal by the CPA was not commercially reasonable. The cited pages critiqued the CPA’s appraisal methodology, but the appellate court agreed with the trial court’s finding that the facts did not rise to the level of showing fraud or that the appraisal was conducted in a commercially unreasonable manner. In sum, the court affirmed the trial court’s granting of partial summary judgment in favor of the plaintiffs and the ruling that the determination by the CPA, which the contracting parties expressly agreed would be conclusive, was binding.
989 N.E.2d 784 (Ind. App. 2013)
A law firm performed legal work for an LLC for several months at the request of Pazmino. The LLC was administratively dissolved during the period in which the law firm rendered services, and neither the LLC not Pazmino paid the firm for its services. The firm sued the LLC for approximately $12,500 plus interest and sued Pazmino for approximately $9,600 plus interest (the amount for services performed after the LLC was dissolved). A default judgment was entered against the LLC. Both the firm and Pazmino sought summary judgment as to Pazmino’s liability for the debts incurred after the LLC’s dissolution. The trial court entered summary judgment in favor of the firm and against Pazmino for the amount sought from Pazmino, and Pazmino appealed. The first issue on appeal was on whose behalf Pazmino was acting. Pazmino contended that he was not personally liable for the LLC’s obligations because he was an employee of the LLC. The firm alleged that even if Pazmino was an employee of the LLC, he was liable for his own acts of personally requesting the firm’s services after the LLC dissolved. The appellate court was not convinced that the evidence established as a matter of law that Pazmino was only an employee of the LLC but declined to address the legal implications of Pazmino’s liability if he was a member or manager of the LLC. The appellate court explained that if the evidence established that Pazmino requested the firm’s services on his own behalf, he would be personally liable for that obligation under the Indiana LLC statute. However, if the evidence showed that Pazmino requested the services on behalf of the LLC such that normally he would not be personally liable for the debt, the firm argued that Pazmino was personally liable because he acted as an agent of a nonexistent principal and because he exceeded the scope of his authority. The firm presented affidavit evidence that Pazmino personally requested and directed the firm as to legal work not relating to the winding up of the LLC after it was administratively dissolved. However, billing records referred to the LLC as the client and the party being billed for the legal work. In addition, the billing records included only a brief description of the work performed and did not establish the services performed were outside the scope of winding up the LLC. The court held that the firm did not establish as a matter of law that Pazmino secured the legal services on his own behalf and thus the firm was not entitled to summary judgment on this issue. The evidence submitted by Pazmino to support his motion for summary judgment was an affidavit in which he claimed to be an employee of the LLC and that the firm did not inform him of the LLC’s dissolution. The court found that a genuine issue of material fact existed as to whether Pazmino had notice of the dissolution, which impacted whether he secured the firm’s services on behalf of the LLC or whether he was acting on his own behalf. The affidavit contained no information as to the work performed by the firm or the purpose of requesting the firm’s services. Like the firm, Pazmino failed to establish as a matter of law that he acted on behalf of the LLC in requesting the legal services and therefore was not entitled to summary judgment on this basis. The next issue addressed by the court was whether after dissolution of the LLC Pazmino could act as an agent on behalf of the LLC because the LLC did not exist except to wind up its business. Generally, an agent who contracts for a nonexistent principal is personally liable on the contract made. The firm contended that Pazmino was personally liable for requesting services not associated with winding up the LLC. According to the Indiana LLC statute, an LLC continues to exist after dissolution to carry on business necessary to wind up and liquidate its business and affairs. Although neither party established as a matter of law whether the work performed by the firm was associated with winding up the LLC, the LLC continued to exist as a principal that could be bound by the acts of its agents regardless of the nature of the work performed by the firm. Finally, the firm argued that Pazmino was not authorized by the LLC statute to wind up or bind the LLC following dissolution. Generally managers and/or members may wind up and bind an LLC after dissolution. The firm also maintained that the limitation on liability did not extend to employees after dissolution. The court agreed that the statute authorizes members to wind up and bind LLCs after dissolution while shielding them from personal liability; however, the court disagreed that an employee who continues to act on behalf of a dissolved LLC is always personally liable for that conduct. The firm specifically alleged that Pazmino was personally liable because he exceeded the scope of his authority under the statute when he, as an employee, requested the firm’s services following dissolution of the LLC. The court stated that none of the cases cited by the firm suggested that an employee properly acting on behalf of a dissolved LLC was personally liable for such acts, and nothing in the statute suggests an intent by the legislature to expose employees of dissolved LLCs acting on behalf of the LLC to personal liability. The statute instead clarifies that even upon dissolution an LLC is responsible for its obligations. The court also reasoned that if the legislature intended to terminate the limitation on personal liability at the LLC’s dissolution, the legislature would have included such a provision. Thus, when Pazmino acted within the scope of the authority conferred by the LLC, the firm’s remedy was against the LLC and not Pazmino.
__ F.Supp.2d __, 2013 WL 173794 (N.D. Iowa 2013)
The plaintiff sued an LLC, the LLC’s members, and several entities who shared some common ownership with the LLC. The LLC dissolved without performing on contracts entered into with the plaintiff, and the plaintiff sought to hold the defendants liable for breach of contract and related claims. The plaintiff argued that it had personal jurisdiction over the LLC as well as the other defendants on the basis that the court was entitled to pierce the corporate veil of the LLC and/or the LLC was the alter ego of the other defendants. After determining that it had specific jurisdiction over the LLC based on the terms of its contract with the plaintiff, the court turned to the questions of whether piercing the LLC’s veil and/or treating it as the alter ego of the other defendants allowed the court to treat the contacts of the LLC as the contacts of the other defendants and whether the plaintiff presented a prima facie case justifying piercing the LLC’s veil or declaring the LLC the alter ego of the other defendants. As a threshold issue, the court determined that the internal affairs doctrine applies to piercing the corporate veil and/or alter ego theories and that Nebraska law thus governed whether the LLC’s veil may be pierced or whether the LLC is the alter ego of the other defendants. Although neither the Iowa courts nor the Eighth Circuit has determined which state’s law applies to questions of piercing the corporate veil or alter ego theories in cases involving an Iowa plaintiff and an out-of-state entity defendant, the court was persuaded that Nebraska law applied because the LLC was a Nebraska entity. The court noted that most jurisdictions recognize the internal affairs doctrine whereby the law of the state of incorporation is used to determine issues relating to the internal affairs of a corporation. The court stated that the internal affairs doctrine applied even though the parties’ contract called for delivery in Iowa because whether or not the independence of an out-of-state entity will be respected is collateral to and not part of the parties’ negotiations or expectations under the contract. The court said the internal affairs doctrine also has the benefit of recognizing that the state of organization generally has the greater interest in determining when or if limited liability may be stripped away from an entity organized under its laws. Finally, the internal affairs doctrine provides consistency and predictability to an entity; consistency and predictability would be eviscerated, rendering investment prohibitive, if an entity were subject to piercing or alter ego theories of each and every state. Because the plaintiff did not allege and the record did not support fraud per se, the court examined the factors set forth by the Nebraska Supreme Court as furnishing a reasonable inference of fraud. First, the court explained that the facts strongly indicated that the LLC was grossly, inadequately capitalized because the five members’ contributions of $54,000 each paled in comparison to the operating costs of the LLC, the members were forced to pay a significant amount of company expenses out-of-pocket to keep the company afloat during the relevant time period, and the members had to take out a personal loan to pay company obligations upon dissolution. Next, the court concluded that the LLC was insolvent at the time it entered into its contracts with the plaintiff. The court then concluded that the members of the LLC, while they did not usurp its assets by ignoring the separateness of the LLC, used the dissolution process as an end run to divert what company funds were available to themselves and other entities of which they were part owners. The court was not persuaded that the final factor, i.e., that the LLC was a mere facade for the personal dealings of its members, was met, but the other factors were sufficient to make out a prima facie showing that the LLC was under the actual control of its members and that the members used their control to commit a wrong in contravention of the plaintiff’s rights. The court next discussed the alter ego theory, stating that the plaintiff had treated piercing the corporate veil and alter ego theory as synonymous but that the term “alter ego” is often used by courts in two incompatible senses. According to the court, in one sense courts refer to a subject entity whose corporate veil has been pierced as the “alter ego” of the shareholders. The court distinguished this usage from a second sense in which courts refer to a subject entity as the “alter ego” of another entity or individual, regardless of whether or not the other entity or individual has an ownership interest in the subject entity. The court stated that this second sense is akin to a finding that the subject entity is acting as the mere agent or instrumentality of the individual or other entity at issue. The court viewed the distinction as important because piercing the corporate veil of a subject entity does not allow a court to impose liability on an individual or entity that is not an owner of the entity. Under the alter ego/instrumentality approach, the court stated that the emphasis is on whether a third party exercised sufficient control over the subject entity such that the subject entity is the mere agent or instrumentality of the third party’s interests, regardless of whether the third party owned a controlling interest in the subject entity. Though the entity defendants other than the LLC had some owners in common with the LLC, the other entities did not own any interest in the LLC, and the plaintiff thus must establish that the LLC was organized, controlled, and conducted so as to make it merely the agency, instrumentality, or adjunct of the other entities. The court stated that a thorough review of the relevant case law in a number of jurisdictions revealed that it was quite rare for a plaintiff to argue, as in this case, that a subject entity that is not owned, at least in part, by a third party is actually the third party’s alter ego. The court found a dearth of Nebraska law in this area and the court relied on factors set forth in Eighth Circuit case law for its analysis. The court stated that alter ego theory requires that the subject entity, the LLC in this case, must be influenced and controlled by the third party entity and not vice versa. Analyzing the dealings between the LLC and the related third party entities, the court concluded that, to the extent the entities operated as a single entity, they did so because the LLC had control and influence over the other entities. Thus, if anything, the other entities were the alter egos of the LLC and not vice versa, and the court stressed that a third party sister or sibling entity controlled by a subject entity will generally not be held responsible for the subject entity’s actions, especially when the third party sister or sibling entity involves minority owners who have no interest in the subject entity. The plaintiff therefore failed to make a prima facie showing that the exercise of personal jurisdiction over the related entities was appropriate based on the alter ego theory.
301 P.3d 709 (Kan. App. 2013)
In this action, Davis sought indemnification of his attorney’s fees under the indemnification provision of the Kansas LLC statute based on the outcome of previous litigation brought by Davis against an LLC and the other members of the LLC. In the litigation, the jury determined that Davis was a member of the LLC and was entitled to $600,000 in damages for breaches of fiduciary duty by the other members. However, the jury also found that Davis was liable to the LLC for $74,788 for breach of contract and was liable in the same amount to the LLC and the other members for negligent misrepresentation. Further, on a declaratory judgment claim by Davis that he held a 49% membership interest in the LLC, the district court determined that Davis’s interest was only 0.96%. In a previous appeal, the court of appeals found that the record supported the findings in the litigation. Davis then brought this action seeking indemnification from the LLC of his attorney’s fees incurred in the original action against the LLC. The Kansas LLC statute authorizes an LLC to indemnify a member subject to any standards and restrictions set forth in the operating agreement and requires indemnification of a member’s reasonable expenses in an action, including attorney’s fees, to the extent that the member has been successful on the merits or otherwise. The LLC argued that there could be only one prevailing party and that Davis was not the prevailing party because he lost on the issue of the extent of his membership interest and on the counterclaims against him for breach of contract and negligent misrepresentation, but Davis argued that he prevailed because he succeeded in establishing that he had an interest in the LLC and obtained a $600,000 judgment for breach of fiduciary duty against the other members. The appellate court focused on the statutory language providing requiring indemnification “to the extent that” a member was successful and concluded that there was no doubt that Davis prevailed in part in the litigation. Davis was thus entitled to indemnification to the extent he was successful. Because the district court erroneously determined by summary judgment that Davis was not entitled to indemnification, it did not reach the question of the amount of fees to be awarded. The appellate court stated that the district court on remand would need to consider not only the extent to which Davis succeeded but the factors set forth in the Kansas Rules of Professional Conduct for use in assessing reasonable attorney’s fees. The court discussed a Delaware case in which partial indemnification of attorney’s fees was at issue in the corporate context. The court noted the similarity between the language used in the Delaware corporate statute and the Kansas LLC statute and pointed out that the factors used under the Delaware Lawyers’ Rules of Professional Conduct and the Kansas Rules of Professional Conduct are the same. The appellate court commended to the district court on remand the Delaware court’s discussion regarding the calculation of indemnifiable fees. Next, the court of appeals distinguished numerous cases relied upon by the LLC for the proposition that the court should apply an abuse-of-discretion standard of review. These cases were inapposite because they apply when an award of attorney’s fees is discretionary and the statute here mandates indemnification. Only the “how much” issue remained discretionary in this case. The court of appeals also addressed other arguments by the LLC that were not reached by the district court. The LLC argued that Davis could not seek indemnification because there was no operating agreement providing for indemnification. According to the LLC, the reference to an operating agreement in the first subsection of the statutory indemnification provision, which permits indemnification subject to any standards and restrictions set forth in the operating agreement, extends to the second subsection mandating indemnification. The appellate court rejected this interpretation and concluded that the lack of an operating agreement did not render the mandatory indemnification provision of the statute inoperative. The court next rejected the LLC’s argument that the LLC indemnification statute is unconstitutionally vague. The statutory provision contains an obvious clerical error in that it first refers to “a member, manager, officer, employee or agent” and then later in the paragraph refers to “such director, officer, employee or agent.” Considering the statute in its entirety, the court was satisfied that the legislature intended the statute to require indemnity for LLC members to the extent they are successful in any suit or proceeding contemplated by the statute. Finally, the court of appeals rejected the LLC’s argument that the statute was not intended to reimburse Davis for prosecution of his personal claim of ownership since it advanced his private interest. The court distinguished a corporate whistle-blower suit in which a former employee was determined not to qualify for indemnification. The court pointed out that Davis’s claims brought to light improper conduct by the other members that affected both the interests of the LLC and Davis. Thus, the court could not conclude as a matter of law that Davis’s suit advanced only his private interest, and the LLC provided no support for the notion that indemnity is not required when the underlying action benefits both the LLC and the individual plaintiff. In sum, Davis was entitled to partial summary judgment on his claim for indemnification, and the district court must determine on remand an amount of recoverable reasonable attorney’s fees.
485 B.R. 562 (Bankr. W.D. Ky. 2013)
The debtor and the defendants in this adversary proceeding were members of an LLC whose operating agreement provided that the LLC would indemnify any member that had to pay as a result of the member’s status as a guarantor. The operating agreement further provided that the other members must pay their pro rata share to a paying member to the extent the LLC does not indemnify the paying member. A bank filed a proof of claim in the debtor’s bankruptcy, and the debtor’s trustee filed this adversary proceeding against the other members, alleging that, to the extent the debtor pays on his guarantee, the LLC will not indemnify him as required by the operating agreement. The defendants argued that the claim against them for indemnification was not ripe, and the trustee argued that Ohio law and the operating agreement allowed the debtor to bring an indemnity claim before making payment to the bank. The court examined the language of the operating agreement and concluded that it expressly authorized indemnification and did not authorize the debtor to make a claim for indemnification before suffering any loss. Furthermore, assuming the debtor made some pre-petition payments to the bank as contended by the trustee, the trustee was not entitled to seek indemnification because the trustee had not made a demand on the LLC seeking redress for the payments as required by the operating agreement. Even if such a demand would yield no results and would thus be futile as alleged by the trustee, the operating agreement required demand, and the claims for indemnity were not ripe until the demand was made.
Zeigler v. Housing Authority of New Orleans
__ So.3d __, 2013 WL 1775057 (La. App. 2013)
Zeigler and his LLC, an inspection company, alleged a scheme on the part of the defendants to take control of a housing program for victims of natural disasters and drive the LLC out of business with the New Orleans Housing Authority. Aside from a claim for intentional infliction of emotional distress, Zeigler only alleged causes of action related to the LLC’s business dealings, and the court of appeals held that the trial court correctly dismissed Zeigler’s claims because he had no standing to sue personally and recover damages suffered by his LLC. The court pointed out that a member of a Louisiana LLC has no interest in LLC property, and members of an LLC thus have no right to sue personally for damages to LLC property. With respect to the intentional infliction of emotional distress claim, the court held that Zeigler failed to state a cause of action because, although both the LLC and Zeigler were negatively affected by the alleged acts, the perceived target as alleged by the pleadings was the LLC rather than Zeigler.
__ So.3d __, 2013 WL 1150429 (La. App. 2013)
The plaintiffs sued an LLC and its members, seeking to hold the members liable for the breach of a construction contract with the LLC by piercing the veil of the LLC. The plaintiffs appealed the trial court’s directed verdict in favor of one of the members and its judgment notwithstanding the verdict as to another. The court of appeals upheld the trial court’s judgment as to both members. With respect to one of the members, Glasser, the plaintiffs argued that the trial court improperly removed him from the judgment despite the jury’s finding him liable. Glasser argued that the jury did not find him liable and that the trial court merely entered judgment in accordance with the verdict. The court of appeals quoted extensively from the trial court’s analysis regarding Glasser’s liability and the trial court’s reasoning for its judgment and agreed with the trial court that the jury did not find Glasser perpetrated fraud on the plaintiffs and that the evidence as to the non-exclusive factors considered in a veil piercing analysis did not support piercing the veil of the LLC as to Glasser. The trial court had no doubt that the jury found that other members were heavily involved in the LLC’s shell game and in defrauding customers such that piercing the veil was warranted as to them, but the only evidence of the five factors enumerated by the Louisiana Supreme Court to be considered in a veil piercing case related to undercapitalization, and there was no evidence that Glasser undercapitalized the LLC. There also was no evidence of any exceptional circumstances that would warrant piercing the veil as to Glasser with respect to any non-exclusive factor. As to whether Glasser had knowledge of the fraud being perpetrated such that he could be held liable without interaction with the plaintiffs, the trial court concluded that there was no evidence that Glasser, who was over a thousand miles away, had any participation or knowledge of what was going on in the business. The court of appeals, upon de novo review, found the trial court properly entered a judgment of dismissal of Glasser. Similarly, the court of appeals, after a de novo review, properly granted a directed verdict in favor of another defendant because the record lacked any evidence that this member perpetrated or was aware of any fraud against the plaintiffs, was involved in the operations and administration of the LLC, or knew of or was responsible for the alleged undercapitalization.
115 So.3d 1204 (La. App. 2013)
The plaintiff and defendant formed an LLC that acquired scrap metal, baled and compacted the scrap, and then re-sold the baled scrap at a profit. The LLC was member-managed, and its only members were the plaintiff and the defendant. The LLC’s articles of organization provided that once each member had been reimbursed for his capital contributions, profits and losses would be divided equally between the members. The parties orally agreed that the defendant’s capital contribution to the LLC would consist of the purchase of a baler, the LLC’s primary piece of equipment, which was crucial to the business’s operation, and other start-up costs. The plaintiff’s capital contribution would consist of his personal services in the daily operation of the LLC and extensive expertise in the scrap metal business. Although the defendant purchased the baler in his name, it was dedicated to the LLC’s operations. The defendant was paid money toward the cost of the baler, and the plaintiff received a monthly salary. After two profitable years, the defendant decided he no longer wanted to operate a business with the plaintiff due to the plaintiff’s failure to repay a personal loan. The defendant demanded possession of the baler and an audit of the business records, and the plaintiff complied. The defendant offered to sell the baler to the plaintiff, but the plaintiff could not afford to buy it, and the defendant would not agree to provide owner financing. The defendant sold the baler to a third party, closed the LLC’s bank account, and retained the proceeds of a workers’ compensation premium refund. Without the baler, the LLC shut down. The plaintiff filed suit seeking damages on a claim of breach of fiduciary duties by the defendant. The trial court found that the baler was a capital contribution to the LLC rather than equipment that was the defendant’s own property rented to the LLC and that the defendant breached his fiduciary duties to the LLC and the plaintiff. The trial court entered judgment in favor of the plaintiff and awarded damages. On appeal, the court first upheld the trial court’s judgment that the baler was a capital contribution to the LLC. The evidence showed that the baler was not, as the defendant argued, the defendant’s individually owned property leased to the LLC. Under the Louisiana LLC statute, a capital contribution is anything of value that a person contributes to the LLC as a prerequisite for or in connection with membership, and a capital contribution does not have to take the form of cash. The record was replete with evidence that the parties agreed the defendant would contribute the baler as capital to the LLC, and the existence of a rental agreement was unsubstantiated by any credible evidence. The appellate court next explained that members entrusted with managing an LLC have a fiduciary relationship with the LLC and its members such that the fiduciary shall act in good faith with the diligence, care, judgment, and skill an ordinary prudent person in a like position would exercise under similar circumstances. The fiduciary obligations include a duty of care and a duty of loyalty such that a fiduciary may not take even the slightest advantage of the principal but must zealously, diligently, and honestly guard the rights of the principal. Fiduciary duties include obligations of utmost good faith, fairness, and honesty in dealing with matters relating to the business. A member has a right of action against other members for breach of fiduciary duties when such breach was grossly negligent and the member was directly damaged. Gross negligence is defined in the Louisiana LLC statute as a reckless disregard or a carelessness amounting to indifference to the best interests of the LLC or its members. The court of appeals concluded that the trial court correctly held that the defendant breached his fiduciary duties to the LLC and to the plaintiff. In reckless disregard of his duties of good faith and loyalty, and without notice to the plaintiff, the defendant sold the baler to a third party and retained the entire purchase price. The defendant emptied the LLC’s banking account and transferred all assets to his own account, and he took possession of the money paid to the LLC by its workers’ compensation insurer. It was undisputed that the baler was the crucial piece of equipment and the heart and soul of the business. The court stated that the defendant’s actions were blatant, malicious, and grossly negligent, and his actions effectively dissolved the LLC and ended the plaintiff’s livelihood. Furthermore, the court concluded that the defendant’s unilateral actions conflicted with Louisiana LLC law, which requires a majority vote of the members to approve a transfer of all or substantially all of the assets of the LLC as well as to approve the dissolution and winding up of the LLC, unless otherwise provided in the LLC’s articles of organization or a written operating agreement. The court characterized the defendant’s actions as selfish and without regard for the plaintiff or the LLC, grossly negligent, and in breach of his fiduciary duties to the plaintiff and the LLC. The court also affirmed the award of damages granted to the plaintiff in the trial court’s judgment.
112 So.3d 909 (La. App. 2013)
Robbins formed an LLC, and shortly after its formation, Prudhome and Fancher each acquired a one-third interest and became members of the LLC. Robbins retained a one-third interest. As consideration for his interest, Fancher paid $10 and provided work and capital for the LLC. At the time, Fancher worked as a consultant for an oil company through which he performed consulting services, and Fancher directed that company’s business to the LLC. This business was the LLC’s primary source of business. The year following the LLC’s formation, Fancher filed suit complaining he was denied access to the LLC’s building and records. After filing suit, Fancher learned of a loan agreement and various leasing agreements that were done without his knowledge. Fancher withdrew from the LLC, asserting that the loan agreement was a breach of confidence. At trial, the main issue was the determination of the fair market value of Fancher’s one-third interest in the LLC at the time of his withdrawal. Fancher’s expert, a CPA, testified that the LLC’s fair market value was $2 million based on a “going concern” analysis, which assumed the business would continue, without a reduction for discounts. The trial court noted that Fancher was a minority interest holder in the LLC who could not make business decisions or require distributions. In addition, because Fancher occupied a unique role in providing the primary source of business to the LLC, the trial court stated that Fancher’s interest was not marketable because its value was indistinguishable from Fancher himself. The trial court found that the fair market value of the plaintiff’s interest was best determined by using the assets approach or book value of the LLC’s equity, which Fancher’s expert listed as almost $38,000. The trial court awarded Fancher almost $12,500 as the value of his share of the LLC at the time of his withdrawal. The trial court also found that Robbins and Prudhome were not personally liable for the debts of the LLC. On appeal, Fancher first alleged that the trial court erred in valuing his interest in the LLC by failing to consider all of the LLC’s assets at the time of his withdrawal. Under the Louisiana LLC statute, a withdrawing member of an LLC is entitled to receive the fair market value of the member’s interest as of the date of withdrawal. The fair market value is generally the price a willing buyer would pay a willing seller in an arm’s length transaction, and the determination may be subject to discounts when the facts support their use. The value of a withdrawing member’s interest may be determined in a number of ways depending on the circumstances. The trial court determined that the income approach, which forecasts future earnings, was not applicable because the LLC’s cash flow could not be assumed due to Fancher’s role in providing most of the business. The market approach also did not apply because the LLC was a small, closely held company with profits tied to the skill of its members such that Fancher’s interest was indistinguishable from himself. The appellate court concluded that the record did not show that the trial court erred in using the book value or assets approach to determine the value of the LLC. Next, Fancher contended that the trial court erred in not finding the other members personally liable for Fancher’s withdrawal distribution. Fancher argued that the members were liable because they were grossly negligent in entering into a loan agreement that assigned 50% of the LLC’s profits to the lender. Citing the Louisiana LLC statute, the court stated that a member who is a manager has a fiduciary duty to the LLC and its members and that members and managers are not personally liable to the LLC or its members unless they acted with gross negligence, which is a reckless disregard of or carelessness amounting to indifference to the best interests of the LLC or its members. Based on the evidence presented, the appellate court found that the trial court was not clearly wrong in finding that the members did not act with reckless disregard of the LLC’s best interest by agreeing to a loan that was necessary to keep the LLC operating. Thus, Fancher’s argument that the members were personally based on gross negligence lacked merit. Fancher also argued that the members were personally liable for the withdrawal distribution because they accepted distributions knowing that the LLC was indebted to Fancher for his one-third interest. Fancher relied on the provision of the Louisiana LLC statute prohibiting distributions when the LLC would be unable to pay its debts as they became due in the usual course of business. Each member who knowingly assents to such a distribution is joint and severally liable to the LLC for the amount of the distribution that exceeds the amount which could have been lawfully distributed. Here, Fancher did not present evidence to support his assertion that the distributions made to the other members caused the LLC to be unable to pay its debts as they became due. Because the record did not contain evidence that the distributions violated the statute, the members were not personally liable for the withdrawal distribution.
109 So.3d 516 (La. App. 2013)
The plaintiff sued an LLC and its sole member based on the faulty construction of a home built by the LLC. The member argued that the contract for the construction of the home was with the LLC and that general corporate law provided no basis for him to be personally liable as a member of the LLC for the debts of the LLC. The plaintiff alleged that the member was personally liable for the construction defects in her home because he personally performed and supervised the construction work. The court of appeals reviewed the provisions of the Louisiana LLC statute providing for limited liability of members and managers and stressed that an LLC is an unincorporated association rather than a corporation. The LLC statute provides that LLC members are liable for their own negligent or wrongful acts and “further specifically limits the parameters for deciding liability of an LLC member to the LLC law itself, thereby precluding consideration of other laws that may be similar in some way.” Thus, the court concluded “that the legislature intended for the personal liability of LLC members of LLCs to be different from the personal liability of corporate shareholders.” In the court’s view, the LLC statute limits an LLC member’s personal liability for the debts, obligations, or liabilities of the LLC unless the debt, obligation, or liability at issue results from the member’s personal actions as specified in the statute. The member attempted to distinguish other LLC cases relied upon by the court on the basis that the member here was not a professional, but the court stated that the statute specifically references “any breach of a professional duty” and “any...other negligent or wrongful act” of a member and makes no distinction between professional and non-professional members. Because the plaintiff alleged that the member engaged in negligent acts with regard to the construction of her home, the court concluded that the plaintiff stated a cause of action against the member. Inasmuch as the member did not assign error to the trial court’s factual finding that he was negligent in the work he performed, the court of appeals found no error in the trial court’s assessment of personal liability against the member. Further, the member did not assign error to the trial court’s finding that he committed fraud when he represented to the plaintiff that the LLC had insurance; therefore, fraud was another basis for the member’s personal liability. The member argued that the trial court erred in finding that he personally was a “builder” under the New Home Warranty Act (NHWA), but the court stated that it need not address this argument because the member’s personal liability arose from personal negligence as a member of the LLC, rendering the question of whether the member met the definition of a builder under the NHWA irrelevant.
__ F.Supp.2d __, 2013 WL 932525 (D. Md. 2013)
The court analyzed whether the veil of a Delaware LLC (initially described by the court as a “Delaware corporation”) could be pierced so as to hold its sole member liable for unlawful debt collection activities. The court stated that Maryland courts have not hesitated to apply Maryland law where a plaintiff seeks to pierce the veil of an out-of-state corporation in connection with violations of a Maryland statute. Here, the parties relied upon Maryland law and did not identify any relevant legal principle that differed from other jurisdictions; therefore, the court applied Maryland law. The court stated that an LLC is treated as a corporation for liability purposes and noted the provision of the Maryland LLC statute providing that members of an LLC are not personally liable for the obligations of an LLC solely by reason of being a member. The court discussed Maryland case law addressing a parent company’s liability for actions of its subsidiaries. The court distinguished the case at hand from Allen v. Dackman, an LLC case in which the Maryland Court of Appeals stated that a member of an LLC is liable for torts personally committed because such liability is not based solely on status as a member. The court stated that the court in Dackman was addressing the situation in which corporate officials sought to rely on their status as LLC members to shield themselves from individual liability for acts taken in their official capacities. The court stated that the plaintiff here sought to hold the sole member liable based on its alleged control of the day-to-day operations but not because it personally committed the acts themselves. The court stated that the complaint did not allege facts that would establish the member’s liability for the acts of its subsidiary. The complaint alleged only conclusory assertions as to control allegedly asserted. A complaint seeking to pierce the corporate veil under Maryland law must allege more than general and conclusory allegations of fraud, undue control, or paramount equity. The complaint must allege facts that indicate fraud or from which fraud is necessarily implied. The court discussed various Maryland cases and concluded that the complaint did not allege facts to support a claim of fraud and had not shown that piercing the veil was necessary to enforce a paramount equity. The court dismissed the complaint with leave to amend.
60 A.3d 475 (Md. App. 2013)
Baystate Properties, LLC (“Baystate”) entered into a contract with Serio Investments, LLC (“Serio Investments”) to build houses on two lots. Serio Investments was to establish an escrow account from which Baystate was to receive scheduled payments, and Baystate was to be paid an additional amount for each house upon the sale of the improved lots. During the course of the work, multiple addenda were presented to Serio Investments. Each of these addenda referenced Serio, the sole member of Serio Investments, individually, but Serio revised these references in each of the addenda and signed them as the managing member of Serio Investments. Serio also obtained from Baystate a signed waiver of any claims of personal liability. When payments began to slow, Serio assured Baystate that the properties would soon be sold. In fact, one of the properties had already sold, and the other sold a few months later. The buyers of one of the houses defaulted on the mortgage, and Serio received only a portion of the sales price. None of the proceeds from either sale were deposited in the Serio Investments account. Serio Investments filed for bankruptcy, and Baystate sought to pierce the veil of Serio Investments and hold Serio personally liable for its obligations to Baystate. The appellate court recognized the liability protection provided members by statute but stated that Maryland “case law has recognized the availability of an action to disregard a limited liability entity congruent with the equitable remedy of piercing the corporate veil.” The court noted that the usual articulation of the standard in the corporate context is that “‘shareholders generally are not liable for debts or obligations of a corporation unless it is necessary to prevent fraud or enforce a paramount equity.’” The court went on to state that “this standard has been so narrowly construed that neither this Court nor the Court of Appeals has ultimately ‘found an equitable interest more important than the state’s interest in limited shareholder liability.’” Although the trial court in this case concluded that the evidence did not support a finding of fraud, the trial court found the evidence sufficient to establish a paramount equity. The trial court considered the following evidence: (1) Serio individually owned the lots and conveyed them individually; (2) Serio gave assurances to Baystate regarding settlement of the lots; (3) Serio lied about the sale and settlement of the first lot; (4) Serio Investments had significant debt and no income besides Serio’s personal deposits, making Serio Investments “‘virtually insolvent;’” and (5) an escrow account was never established as provided for in the agreement with Baystate despite statements by Serio that an escrow account would be created. The appellate court noted that many Maryland cases have addressed fraudulent activity justifying disregard of the corporate entity, but few decisions have explained or applied the concept of a “paramount equity” although the language used in the cases suggests it is a basis to disregard the corporate entity distinct from fraud. The appellate court reviewed Maryland case law and commentary at length and observed that even decisions recognizing alternate grounds for piercing the corporate veil have not done so absent a finding of fraud. What the trial court found most troubling was that Serio misled Baystate regarding the sale of the homes and failed to establish an escrow account. In the trial court’s view, the failure to deposit the sale proceeds into Serio Investments and the subsequent bankruptcy filing evidenced an intent to evade the legal obligations to Baystate. However, the appellate court was not convinced that these facts established the “exceptional circumstances” necessary to warrant holding Serio personally liable. The court pointed out that Baystate contracted with Serio Investments, a valid, subsisting LLC at the time, and Baystate apparently was aware that the lots were in Serio’s name prior to entering into the agreement. There was no evidence that Baystate ever questioned or challenged the failure to establish a funded escrow account, and Serio made it clear (at the outset, with each addendum, and in a waiver of personal liability) that Serio Investments was the party liable on the contract. Although Serio Investments might have been undercapitalized (sometimes having only $100 in its account), there was no evidence that Baystate entered into the agreement depending upon Serio to fund its contracts from his personal account or that Baystate took reasonable steps to assure the availability of adequate funding. All payments made to Baystate under the contract were made by checks on the corporate account of Serio Investments or cashier’s checks funded by Serio Investments. Transfers by Serio to Serio Investments were documented by confessed judgment promissory notes indicating the payments were loans and not mere commingling of funds. Serio Investments fulfilled its contract until, as Serio testified, the collapse of the housing market caused problems. Baystate was an established building contractor who understood it was dealing with another LLC, and the trial court abused its discretion in holding Serio personally liable for the obligations of Serio Investments.
989 N.E.2d 847 (Mass. 2013)
The plaintiff sued an LLC and its two managers for unpaid wages under the Massachusetts Wage Act. The issue before the court was whether the individual managers could be liable as a “person having employees in his service.” The court discussed provisions of the statute specifying that corporate officers and agents with management responsibilities, along with public officers who have a duty to pay or perform official acts in connection with payment of public employees, are deemed employers for purposes of liability for unpaid wages. The court concluded that the absence of provisions mentioning managers of LLCs or other limited liability entities (including the failure to adopt a proposed amendment to include LLCs, limited liability partnerships, and other entities in the corporate officer provision) does not evince a legislative intent to distinguish between corporate actors and the managers of other limited liability entities. Rather, the court concluded that the inclusion of provisions addressing liability of corporate and public officer liability showed “a clear legislative intent to ensure that individuals with the authority to shape the employment and financial policies of an entity be liable for the obligations of that entity to its employees.” Thus, the lower court’s dismissal of the individual managers was reversed, and the case was remanded for further proceedings.
__ F.Supp.2d __, 2013 WL 1332009 (D. Minn. 2013)
Mr. and Mrs. Damon sought to recover damages incurred in connection with the purchase of a commercial office building. The defendants argued that the Damons could not recover individually because they formed an LLC to own the building and limit their personal liability and they sought as individuals to recover damages that were incurred by the LLC. The court stated that it understood the economic reality that the Damons, as sole members, contributed the funds at issue, but the court would “not allow the Damons to take advantage of the corporate form to limit personal liability while simultaneously ignoring the corporate form when doing so allows them to profit personally.” The court concluded that the Damons could properly seek to recover the damages incurred personally before they created the LLC and transferred the building to the LLC, and the court allowed further briefing to address the possibility that it would not work an injustice if the LLC were added as a party.
Croteau v. National Better Living Association, Inc.
__ F.R.D. __, 2013 WL 3030629 (D. Mont. 2013)
One of the defendants, an administratively dissolved Tennessee LLC that had filed articles of termination stipulating that all assets had been distributed to creditors and members, argued that it lacked capacity to be sued and should be dismissed because its legal capacity had terminated and its had been assets distributed prior to the filing of the suit. The court concluded that the plaintiffs were entitled to proceed on a theory of successor liability based on Tennessee LLC law. The LLC argued that the plaintiffs’ claims were barred because filing articles of termination demonstrates that all the LLC’s assets have been distributed, and the general claim termination provision of the Tennessee LLC statute provides that creditors whose claims are not barred may proceed only against the dissolved LLC to the extent of its undistributed assets. The court stated that the LLC statute was phrased in the disjunctive so that if a dissolved LLC provides neither specific notice to creditors nor notice by publication, a creditor may proceed against either the dissolved LLC to the extent of its undistributed assets or against members or holders of financial rights of the dissolved LLC within three years after the filing of articles of termination. Thus, the court concluded that the LLC did not lack capacity to be sued because, even though its assets had been distributed, the plaintiffs might be able to proceed against members or holders of financial rights of the dissolved LLC. The LLC did not produce information regarding termination of creditors’ claims by specific notice or publication, and the suit was filed within three years after the articles of termination were filed with the Tennessee Secretary of State. Thus, the court held that the plaintiffs’ claims of successor liability were legally sufficient under the LLC statute and were not barred as a matter of law for lack of capacity of the LLC. The court commented that joinder of individuals or entities might be required if discovery revealed information supporting claims against members or holders of financial rights of the dissolved LLC.
__ N.W.2d __, 2013 WL 2479709 (Neb. App. 2013)
The plaintiff was one of 11 children of Constance Klingelhoefer, and the plaintiff sued the law firm hired by his mother to develop and implement an estate plan. As part of her estate plan, the plaintiff’s mother formed an LLC, transferred her real estate to the LLC, and gave interests in the LLC to her 11 children. The plaintiff’s mother also created a trust to which she transferred her personal property. After the plaintiff’s mother died, the plaintiff brought a professional negligence action against the law firm hired by his mother. The law firm filed a motion to dismiss based primarily on the plaintiff’s lack of standing to bring an action in his own name for injuries he allegedly suffered as a member of the LLC and beneficiary of the trust. The plaintiff filed an amended complaint in which he changed the caption of the suit to reflect he was suing individually and as beneficiary of the trust and representative of the LLC. He inserted an allegation that he did not secure initiation of the action against the LLC by the manager and certain other members because it would be futile since the manager and other members were beneficiaries of the misconduct and previously represented by the law firm. The plaintiff did not include an allegation that he had requested that the LLC file the action or why such request would be futile. After the plaintiff filed the amended complaint, the trial court granted the summary judgment in favor of the law firm on the basis that the plaintiff lacked standing to maintain a professional negligence action against the law firm as an heir of his mother or member of the LLC and that the law firm owed no duty to the plaintiff as a beneficiary of the trust. The court of appeals affirmed the trial court’s judgment. The court of appeals first determined that the plaintiff did not plead a derivative action. The Nebraska LLC statute allows for a member derivative action if the member makes a demand on the manager or a demand is futile. A member bringing a derivative action must set forth in the complaint what actions were taken to comply with the statute. The plaintiff did not allege that he requested the manager to institute a professional negligence action but rather stated that it would have been futile to request the manager to initiate an action against the LLC. Even construing the pleading as an attempt to comply with the statute, the plaintiff did not allege that he brought his claims on behalf of the LLC. Further, the complaint here sought damages based on an interpretation of the trust and LLC that was rejected by the court in a prior suit brought by the plaintiff; therefore, this action reflected a position adverse to the established intent of the trust and LLC. It was clear to the court that the plaintiff’s personal interests rather than the entity’s interests were at the forefront of the litigation. The court went on to analyze the nature of the harm alleged by the plaintiff in light of principles applicable to corporate derivative suits applied by the Nebraska Supreme Court in the LLC context. The court concluded that the plaintiff did not allege any injury separate and distinct from the harm allegedly suffered by other non-farming members of the LLC. Neither did the plaintiff show any special duty was owed to him separate and distinct from the duty owed to the LLC. The court explained that this case was distinguishable from a case in which the Nebraska Supreme Court held that an attorney’s duty extended to two shareholders of a closely held corporation that hired the attorney. In that case, the shareholders were a husband and wife who communicated directly with the attorney and whose interests were profoundly affected by whatever affected the corporation. Also, the corporation joined in the action against the attorney. Here, the plaintiff’s mother was the sole founder of the LLC and trust, she hired the attorney and communicated with the attorney, and it was the mother’s interests that the attorney was representing, not necessarily the interests of the plaintiff or his siblings (as evidenced by the fact that the plaintiff’s mother included special provisions for her farming sons). Furthermore, extension of the attorney’s duty to the plaintiff as a member of the LLC and beneficiary of the trust would necessarily extend the duty to the plaintiff’s siblings, thus creating conflicting loyalties. The plaintiff complained of the attorney’s actions that benefitted three of his siblings to the detriment of others, but the attorney was charged with drafting and carrying out the provisions of the documents through representation of the plaintiff’s mother, regardless of the beneficial or detrimental effect it had on the individual beneficiaries of the trust or members of the LLC. In sum, the plaintiff did not have standing to bring the action, and legal representation of the plaintiff’s mother did not equate to protection of the plaintiff and his siblings.
62 A.3d 838 (N.H. 2013)
In 2005, Gistis and Johnston agreed to purchase a greyhound race track though a court-approved bidding process. The two formed a joint venture in which Johnston’s development company (“Johnston Development”) would bid on the race track and Gistis would provide the required deposit. Johnston Development successfully bid over $4 million to buy the race track, and Gistis provided the $205,000 deposit in connection with the purchase. Shortly thereafter, Johnston Development and Gistis formed an LLC to own and manage the race track. The other members of the LLC were Miller and two other individuals. The parties agreed Johnston Development would contribute its right to purchase the race track to the LLC as part of the company’s capitalization, and the LLC would own the race track. Johnston Development and the seller entered a purchase and sale agreement with a two-month period for Johnston Development to conduct its due diligence. If the seller was not notified of an intent to proceed with the transaction by July 18, the deposit would be forfeited. In June, a New Hampshire grand jury indicted a dozen people involved with the track, and the LLC members decided to try to sell their right to purchase the track and recoup expenses rather than to close on the transaction. Without the knowledge of the other members of the LLC, Miller and Johnston had been negotiating the right to purchase the track with numerous potential buyers. On July 17, Torguson Gaming Group, Inc. (“Torguson”) agreed to pay $5 million to Johnston for the right to purchase the race track. In addition, Miller paid the seller $50,000 to extend the due diligence period and have the deposit remain in the escrow account. Torguson then replaced the deposit made by Gistis, and the seller returned Gistis’s deposit. Johnston Development made a profit of almost $900,000 in its sale to Torguson, and Johnston transferred $445,000 of the profit to Miller. The LLC and its members (other than Miller and Johnston Development) filed suit against Johnston, Johnston Development, and Miller alleging, among other causes of action, breach of fiduciary duty. A default judgment was entered against Johnston and Johnston Development, and the claim against Miller proceeded to trial. The trial court found that Miller breached his fiduciary duties to the plaintiffs by using the original deposit made by Gistis and belonging to the LLC to appropriate the opportunity to sell the purchase rights to Torguson. Miller appealed alleging that the plaintiffs did not have standing to sue for breach of fiduciary duty and that the LLC’s operating agreement allowed his actions in connection with the sale to Torguson. First, Miller argued that the assets at issue, which were the right to purchase the race track and the deposit, did not belong to the LLC and that the plaintiffs lacked standing to bring an action based on them. Although this issue was not raised at trial, the appellate court addressed it as it dealt with the trial court’s subject matter jurisdiction. The trial court found that both the right to purchase the race track and the deposit held in escrow belonged to the LLC. The trial court found that Johnston had an obligation to transfer his rights at closing, which the LLC could have enforced. At the very least, the LLC had a cause of action for specific performance to require transfer of those rights so the closing could have occurred. In addition, the deposit, while in escrow, was to be used only for the benefit of the LLC. Therefore, the LLC and its members had standing to sue for breach of fiduciary duty. Next, the defendant contended that the trial court erred when it failed to consider a paragraph in the LLC’s operating agreement that allowed competition with the LLC with or without notice to or participation by the other LLC members without such conduct constituting a breach of fiduciary duty. Miller argued that his conduct involving negotiations with alternate buyers constituted competition, as allowed by the operating agreement. The plaintiffs countered that Miller was not merely competing with the LLC but rather sold the LLC’s primary business asset (i.e., the right to purchase the race track) and secretly used Gistis’s deposit to do so. The appellate court agreed with the plaintiffs that the LLC’s operating agreement did not allow Miller to use the LLC’s assets to enrich himself. Miller’s argument mistakenly assumed that the purchase right and deposit did not belong to the LLC; however, as discussed above, the trial court found that both assets belonged to the LLC, and the appellate court upheld the finding on appeal. Therefore, Miller’s actions constituted breach of the fiduciary duties he owed the plaintiffs, and the appellate court affirmed the trial court’s judgment.
487 B.R. 289 (Bankr. D.N.M. 2013)
In the course of addressing whether the automatic stay in this bankruptcy applied to an action pending in a Virgin Islands court against the wholly owned Virgin Islands LLC of the debtor, the court addressed the question of the effect of the member’s bankruptcy on his ownership interest and management rights. Under the Virgin Islands LLC statute, an LLC member becomes dissociated when the member files bankruptcy. Upon dissociation, a member is no longer a member and can no longer participate in the management and conduct of the company. The court stated that this provision, which is taken from the Uniform Limited Liability Company Act (1996), conflicts with Section 541(c)(1) of the Bankruptcy Code, which provides that an interest of the debtor in property becomes property of the estate notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law that restricts or conditions transfer of the interest or that is conditioned on the commencement of a bankruptcy case. The court cited cases addressing the conflict that have held that state law provisions like the Virgin Islands provision are preempted by Section 541(c)(1) and noted that some cases have held that such state law provisions make little sense in the case of a single-member LLC. Based on these authorities, the court held that the debtor’s bankruptcy filing did not diminish the debtor’s membership or management rights and that the debtor continued as the sole member and manager of the LLC. The court also discussed a dispute as to the effect of the member’s post-petition dissolution of the LLC and purported transfer of shares of a corporation purchased by the LLC under an agreement entered into before the bankruptcy. The seller of the shares argued that the transfer of the shares was ineffective based on the seller’s alleged pre-petition termination of the share purchase agreement after the LLC’s default in payment of the purchase price. Alternatively, the seller argued that the transfer of the shares violated the winding up provisions of the LLC statute because the LLC did not pay the balance of the purchase price for the shares owed by the LLC to the seller of the shares. The debtor argued that the share transfer in the dissolution was proper because the seller was the only creditor and the LLC’s claims and defenses against the seller reduced the seller’s claim to zero. The court stated that it need not resolve the dispute because the law was clear that the transfer was not void even if it violated the statute but rather would give rise to additional claims against the debtor and the LLC, including potential trust fund and fraudulent transfer claims. The court also noted that the transfer of the shares may not have been properly authorized by the court as a transaction not in the ordinary course of the debtor’s business. Such an action would be potentially voidable and was effective to bring the shares into the estate assuming the LLC had anything to transfer. Finally, the court addressed the application of the automatic stay to the litigation brought by the seller in the Virgin Islands action. The court acknowledged that the automatic stay ordinarily does not apply to the assets of a debtor’s subsidiary, even a wholly owned subsidiary like the LLC here. Because there was a bona fide dispute as to the effectiveness of the seller’s attempted pre-petition termination of the purchase agreement and the consequences of the attempted termination, the court determined that the estate, post-transfer, had a sufficient interest in the shares for the automatic stay to apply. The court commented that it was not condoning the eleventh-hour upstreaming of the shares without court approval and with the obvious goal of obtaining the benefit of the automatic stay, and the court set forth a number of considerations underlying its decision in the case.
985 N.E.2d 893 (N.Y. 2013)
In 2006, Fundamental Long Term Care Holdings, LLC (“Fundamental”), an LLC whose members were Grunstein and Forman, entered into an option agreement with Cammeby’s Funding LLC (“Cam Funding”), an LLC wholly owned by Schron, under which Cam Funding was entitled to acquire one-third of Fundamental’s membership units for a strike price of $1,000, provided the option was exercised no later than June 9, 2011. Grunstein and Forman formed Fundamental for the purpose of owning companies that manage health care facilities, and they each contributed $50 in equity for a half-interest in Fundamental and paid $10 million, financed by debt, to purchase from an entity controlled by Schron the stock of 26 nursing home facilities. The option agreement provided that Cam Funding would be admitted as a member of Fundamental upon exercise of the option and that Fundamental would execute certificates for the acquired units and all other documents necessary to properly issue the acquired units, and Grunstein and Forman agreed, as the sole members of Fundamental, to consent to the issuance of the acquired units and the admission of Cam Funding as a member and to execute and deliver amendments and schedules to the operating agreement of Fundamental to reflect the issuance of the acquired units. The option agreement also required Fundamental, Grunstein, and Forman to facilitate, and prohibited their interference with, the exercise of the option and provided that any conflicting agreement or commitment would be deemed void. Finally, the option agreement contained a standard merger clause. In late 2010, Cam Funding notified Fundamental that it was exercising the option and enclosed a $1,000 certified check. Fundamental responded that its operating agreement provided that additional membership units could not be issued without a capital contribution equal to at least the fair market value of the proposed interest, which was estimated to be $33 million. Fundamental sued for a declaration that Cam Funding was bound by the membership requirements in the operating agreement to make the requisite capital contribution, and Cam Funding counterclaimed for breach of contract. The trial court ruled that the option agreement unambiguously granted the right to acquire a one-third interest in Fundamental upon payment of $1,000, and the appellate division affirmed. The New York Court of Appeals affirmed the appellate division. New York’s high court rejected Fundamental’s argument that the option agreement and operating agreement must be read together, stating that the two agreements were not inextricably intertwined. The court stated that the breach of one agreement would not undo the obligations imposed by the other, and an obligation for the fair market value to be due upon Cam Funding’s exercise of the option was not the sort of term these sophisticated, counseled parties would have reasonably left out of the option agreement. Mere reference to the operating agreement in the option agreement was not enough to evidence clear intent for the two contracts to be read as one. Furthermore, whether payment of $1,000 for a membership interest valued at $33 million was commercially unreasonable was irrelevant. The court stated that an inquiry into commercial reasonableness is only justified when a contract is ambiguous, and the option here was unambiguous. The court noted that, in any event, parties enter into option agreements for all sorts of reasons, and this agreement was executed by sophisticated, counseled parties.
967 N.Y.S.2d 119 (App. Div. 2d Dept. 2013)
Two entities executed an operating agreement governing an LLC formed for the purpose of purchasing and operating an office building. One party was designated the “common capital member” and “managing member,” and the other was designated the “preferred capital member.” The operating agreement contained a provision specifying that any modification of the operating agreement must be in writing. After economic conditions worsened and the building began losing tenants, the members began discussing potential transactions to restructure the LLC or sell the preferred member’s interest to the managing member. After months of negotiations, the parties orally agreed that the managing member would purchase the preferred member’s interest at a discounted price. The agreement was never reduced to writing, and the preferred member ultimately refused to go through with the alleged buyout agreement. The managing member sued the preferred member for breach of contract, fraud, and negligent misrepresentation. The preferred member argued that enforcement of the alleged oral buyout agreement was barred by the provision of the operating agreement requiring amendments to be in writing. The court held that the oral buyout agreement did not modify the terms of the conditions of the operating agreement, but was a separate additional agreement addressing a situation not covered by the operating agreement. The complaint alleged that the parties orally agreed on all of the material terms of the sale of the preferred member’s interest and thus stated a cause of action for breach of contract. The court held that the fraud claim was properly dismissed because a fraud action does not lie where the only alleged fraud relates to an alleged breach of contract. Further, the court stated that a general allegation that a party entered into a contract with no intention to perform is insufficient to state a cause of action to recover damages for fraud. The negligent misrepresentation claim was also properly dismissed because the managing member failed to allege any misrepresentation that was collateral or extraneous to the alleged contract.
966 N.Y.S.2d 797 (App. Div. 4th Dept. 2013)
Rosenberg and Jerry entered into an LLC operating agreement in 2002. The LLC was formed for the purpose of acquiring underdeveloped real property and developing a commercial subdivision for the construction and operation of hotels. Rosenberg died in 2010, and the co-executors of his estate filed a suit for breach of contract, an accounting, and dissolution against Jerry and the LLC. The defendants asserted counterclaims, sought a declaration of the rights of the parties, and moved for summary judgment. The trial court granted the defendants’ motions and denied the plaintiffs’ cross motion. The appellate court found that the trial court properly determined the defendants were entitled to summary judgment but failed to declare the rights of the parties. The court modified the judgment by making the requisite declarations. First, the court addressed the plaintiffs’ claim that the decedent’s estate was not required to give written notice of its intent to transfer the decedent’s membership interest in the LLC. The court disagreed based on its interpretation of the operating agreement. The operating agreement clearly and unambiguously provided that if a member died, that member shall be deemed to have offered his or her membership interest to the other members for sale and shall give written notice to the other members of his, her, or its intention to transfer such membership interest. Thus, the plain language of the agreement provided for the decedent’s estate to give written notice of its intent to sell. The court also found that the trial court properly interpreted the operating agreement in determining that the date of valuation of the decedent’s interest was the date of his death. The operating agreement further provided that the purchase price of a membership interest shall be determined based on a fair market appraisal of the real property owned by the LLC and that the value of the LLC included goodwill. The plaintiffs contended that they would be entitled to essentially nothing under the provision because the LLC owned only a small vacant parcel of land since the LLC had transferred the real property it had owned in exchange for an interest in two entities that developed hotels on that property. However, the court pointed out that the defendants had admitted at oral argument that the value of the LLC included the appraised value of the hotels that currently existed on the real property in which the LLC had an interest. Therefore, the court modified the judgment to adjudge and declare that: the decedent was deemed to have offered his membership interest in the LLC to the defendants at his death; the estate of the decedent must give written notice of its intent to sell; and the purchase price of the membership interest was to be based on the appraised valuation of the commercial real property of the LLC as of the date of the decedent’s death.
966 N.Y.S.2d 454 (App. Div. 2d Dept. 2013)
The plaintiff and Alston formed an LLC in which each owned a 50% interest. After Alston’s death, the plaintiff commenced an action for partition against the LLC and the administrator of Alston’s estate. After proceedings in which the supreme court and appellate court determined that the LLC had not been dissolved six years before Alston’s death by the plaintiff’s alleged expulsion from the LLC, the action was transferred to the surrogate’s court, which granted summary judgment to the plaintiff on the basis that the LLC was dissolved by Alston’s death. The appellate court held that the surrogate court properly determined that the LLC was dissolved by Alston’s death. The previous appeal rejecting the defendants’ argument that the action was time-barred by dissolution of the LLC six years before Alston’s death by the alleged expulsion of the plaintiff was the law of the case and precluded re-examination of that issue.
963 N.Y.S.2d 645 (App. Div. 1st Dept. 2013)
The court explained the distinction between advancement of legal fees and indemnification and concluded that the broad language of a servicing agreement between the parties entitled the plaintiff member of an LLC to advancement of its legal fees for prosecuting its claims against the LLC and defending against the counterclaims asserted by the LLC. The provision applied to “any and all claims, demands, actions, suits or proceedings” so long as the plaintiff’s involvement in the proceedings is by reason of its service to the LLC and the plaintiff provided a statement that it agreed to reimburse the LLC in the event it was ultimately determined that the plaintiff was not entitled to indemnity. The court rejected the argument that the provision did not include intra-party claims and held the lower court properly determined that the plaintiff was entitled to advancement of its legal fees until the question of the plaintiff’s entitlement to indemnification was ultimately determined.
963 N.Y.S.2d 29 (App. Div. 1st Dept. 2013)
Affidavits in which the affiants asserted that a former manager of an LLC told the affiants that the manager was actually an owner did not raise a fact issue as to the authenticity of the operating agreement where the operating agreement contradicted these assertions. Further, because this was a dissolution action and not an action for fraud, assertions that there were no documents in the manager’s name because he used other people’s names to conceal his holdings were insufficient to raise a fact question as to the authenticity of the operating agreement.
961 N.Y.S.2d 538 (App. Div. 2d Dept. 2013)
The plaintiff and defendant were the members of an LLC formed in 2000 for the purpose of the construction and operation of a mixed-use commercial and residential building. After formation of the LLC, the parties purchased real property on which to construct the LLC’s building. The seller required an LLC agreement, which the parties did not execute initially when forming the LLC, so the attorney who represented both parties at the closing drafted an LLC agreement. The LLC agreement provided that each member owned a 50% membership interest in the LLC. The agreement did not state the amount of the parties’ capital contributions but provided that after the initial capital contributions by the parties no member would be required to contribute additional capital unless required by a vote of all of the members of the LLC. The agreement also contained a provision that no member would have the right to receive any return of any capital contribution subject to certain exceptions not relevant to the litigation. According to the LLC agreement, the LLC could be dissolved only upon the occurrence of certain specified events, and at dissolution the assets were to be distributed first to the LLC creditors and then to the members in proportion to their respective ownership shares. The members contributed approximately equal funds toward the down payment on the LLC’s property. The building’s construction was financed largely by a construction loan, which the parties refinanced into a mortgage loan. Through 2003, the parties made approximately equal capital contributions to the LLC. After that, the plaintiff contributed around $1.4 million in capital to the LLC while the defendant contributed approximately $317,000 in capital to the LLC. In 2006, the construction was complete and the parties moved their offices into the building. An accountant for the LLC testified at a hearing that the LLC experienced net operating losses in each year from 2006 through the first half of 2011 and that the LLC would have failed if not for the use of the proceeds of the mortgage loan and capital infusions by the plaintiff to cover the LLC’s net operating expenses. The plaintiff filed suit to recover damages for breach of fiduciary duty and breach of contract, but the trial court granted the plaintiff’s application for the judicial dissolution of the LLC. The plaintiff also sought an order authorizing him to purchase the defendant’s interest in the LLC at dissolution. The appellate court reviewed the trial court’s ruling and concluded that the trial court did not err in dismissing the plaintiff’s cause of action to recover damages for breach of fiduciary duty because that cause of action was not properly brought in the plaintiff’s individual capacity. Next, the court held that the trial court did not err in dismissing the cause of action to recover damages for breach of contract. Despite the defendant’s protest, the trial court correctly found that the LLC agreement was ambiguous and that parol evidence of the parties’ course of dealing was admissible to supplement and interpret the terms of the agreement. In addition, evidence of the parties’ conduct with respect to capital contributions did not constitute a prior oral agreement or an impermissible oral modification of the contract. Even considering the evidence, the court found that the plaintiff failed to establish the existence of a binding agreement as to the parties’ responsibility for capital contributions, and thus the plaintiff failed to show a breach of contract. The court next found that the trial court properly granted the plaintiff’s application for judicial dissolution of the LLC because it was not reasonably practicable for the LLC to continue operating due to financial infeasibility. The court also held that the trial court did not err in determining that the capital contributions of the plaintiff were to be treated as loans to the LLC to the extent those contributions exceeded the contributions made by the defendant. The LLC agreement did contain a provision that a member did not have the right to receive any return of capital contributions, but the agreement also provided for the repayment of debts of the LLC upon dissolution. The agreement was silent as to the issue of equalization of capital contributions, and an affidavit submitted by the defendant established that the parties intended for the capital contributions contributed by the plaintiff to be treated as loans to the LLC to the extent the contributions exceeded those made by the defendant. Finally, the court held that the trial court should have granted the plaintiff’s application for an order authorizing him to buy the defendant’s interest in the LLC at its dissolution. The court stated that a buyout in dissolution proceedings can be an appropriate equitable remedy in certain circumstances. The court found that allowing the plaintiff to buy out the defendant’s interest in the LLC upon dissolution was appropriate under the facts of the case. The LLC agreement did not contain provisions that precluded an order authorizing a buyout upon the judicial dissolution of the LLC despite the defendant’s contentions to the contrary. The court remanded to the trial court for further proceedings to determine the value of the defendant’s interest in the LLC for buyout purposes but otherwise affirmed the trial court’s judgment.
961 N.Y.S.2d 383 (App. Div. 1st Dept. 2013)
The plaintiff’s claim for breach of a stock purchase agreement against the managing member of an LLC failed because the managing member signed the agreement only in his capacity as managing member of the LLC and could not be held liable for the LLC’s breach. The plaintiff’s fraudulent inducement claim against the managing member failed because the claim was based on a pre-contractual representation by the managing member that was barred by the merger/integration clause in the stock purchase agreement. A claim against the managing member for unjust enrichment, which was based on the LLC’s failure to pay for goods received by the LLC, failed because the complaint did not contain allegations sufficient to pierce the LLC’s veil.
959 N.Y.S.2d 200 (App. Div. 1st Dept. 2013)
The plaintiff’s allegations that he was systematically excluded from an LLC were insufficient to establish that it was not reasonably practicable to carry on the LLC’s business as required for judicial dissolution. The allegations did not show unwillingness of management to reasonably permit or promote the stated purpose of the entity or that continuing the entity was financially infeasible. According to the court, the allegation that the defendants failed to pay the plaintiff his share of the profits and make distributions to the plaintiff showed that the LLC had been able to carry on its business since the plaintiff’s alleged expulsion and that the LLC was financially feasible.
959 N.Y.S.2d 218 (App. Div. 2d Dept. 2013)
The plaintiff, an LLC that was a member of another LLC, was not a party to the 2006 operating agreement of the second LLC and thus could not assert claims for breach of that agreement where the plaintiff was not yet formed in 2006 and the agreement was signed only by the defendant. The plaintiff’s affidavit advancing new causes of action based on a 2007 operating agreement without leave to replead or amend did not remedy the defect in pleading. The plaintiff’s unjust enrichment claim failed because the 2007 operating agreement was an express agreement between the parties.
958 N.Y.S.2d 467 (App. Div. 2d Dept. 2013)
The appellate court held that the lower court properly dismissed the plaintiff’s dental malpractice claim against the sole “shareholder” of a PLLC because, contrary to the plaintiff’s assertion, the status of sole “shareholder” of an LLC was not sufficient to make the individual vicariously liable for another individual’s conduct. According to the court, “[a] shareholder, employee, or officer of a limited liability company is liable only for negligent or wrongful acts ‘committed by him or her or by any person under his or her direct supervision and control while rendering professional services in his or her capacity as a member, manager, employee or agent of such professional service limited liability company.’”
738 S.E.2d 802 (N.C. App. 2013)
In the course of discussing whether a housing development qualified for ad valorem tax exemption as a low-income housing development owned by a nonprofit corporation, the court quoted a description by the U.S. Department of Housing and Urban Development of the use of LLCs as a common ownership structure for low income housing developments. The structure in this case involved ownership of the housing development by an LLC with a .1% managing member that was a nonprofit corporation and a 99.9% investor member that was a limited partnership. The court concluded that the housing complex qualified for the tax exemption. The court relied in part on its conclusion that the managing member was, by virtue of North Carolina LLC law and the managing member’s management of the LLC’s operations and property, trustee of the LLC property under an “active trust.” The court also relied on a provision of the LLC operating agreement that gave the managing member a right of first refusal to purchase the investor member’s interest at the end of a 15-year term. The likelihood of a buyout was one factor suggesting ownership. The court said that the evidence suggested that the investor member did not seek a typical goal of ownership in that it sought to obtain tax credits rather than obtain profits. On balance, notwithstanding the managing member’s small ownership percentage, the court concluded that substantial factors indicated the managing member owned the housing complex for tax purposes.
490 B.R. 675 (Bankr. E.D. Penn. 2013)
An LLC mortgagee objected to the discharge of the debtor’s debt to the LLC and asserted claims under state law against the debtor. The LLC relied on an exception to discharge for certain types of debts when the creditor has no notice of the bankruptcy case. The debtor argued that the provision on which the LLC relied did not apply because the LLC had been dissolved before the debtor’s Chapter 7 case and the LLC thus could not complain that it did not receive notice of the bankruptcy. The debtor provided evidence from the Corporation Division of the Commonwealth of Massachusetts of the LLC’s administrative dissolution and argued that an administratively dissolved LLC is a legal nullity that can be disregarded by persons who had business relationships with it. The court stated that the evidence of the LLC’s administrative dissolution did not aid the debtor because the Massachusetts LLC statute did not support the debtor’s argument. The Massachusetts LLC statute provides that an administratively dissolved LLC continues in existence but shall not carry on any business except as necessary to wind up. Thus, the LLC continued to exist after its dissolution and was entitled to protect its interest in the debtor’s Chapter 7 case and should have received notice of the bankruptcy. The court noted in a footnote that the debtor’s evidence of administrative dissolution also showed that the LLC was reinstated. The court commented that reinstatement of a Massachusetts corporation may be retroactive but that the Massachusetts LLC statute has no analogous provision. The court offered on opinion as to whether the Massachusetts courts would read retroactivity into the LLC statute.
__ S.E.2d __, 2013 WL 3200596 (S.C. 2013)
The present action was the culmination of a long and contentious dispute between two members of an LLC. Kriti Ripley, LLC (“Kriti”) and Emerald Investments, LLC (“Emerald”) formed an LLC to develop property. Emerald and its sole member, Longman, decided to develop condominiums and a marina on a piece of property in Charleston. When experiencing financial difficulties, Emerald and Longman turned to Kriti, an outside investor. Emerald and Kriti formed the LLC, and under the operating agreement, Emerald made in-kind contributions of the property for its 70% share in the LLC, and Kriti contributed $1.25 million for its 30% share in the LLC. Emerald and Longman diverted and misappropriated Kriti’s funds and took actions prohibited by the operating agreement. Kriti and the LLC obtained a judgment against Emerald and Longman based on an arbitration award. Emerald was stripped of its voting rights and management of the LLC. Emerald and Longman refused to pay any amount toward the judgment obtained by the plaintiffs and instead engaged in a pattern of abusive litigation to delay and avoid payment. The plaintiffs obtained a charging order against Emerald’s interest and moved to foreclose on that interest. The trial court denied the motion for foreclosure explaining that foreclosure was a drastic remedy and that South Carolina courts had a long-standing judicial policy to avoid forfeiture. The trial court held that foreclosure was not the appropriate remedy and that the charging order was sufficient to protect the plaintiffs’ interest. The South Carolina Supreme Court reversed and remanded, holding that the trial court committed several errors in denying the motion to foreclose and that foreclosure and sale of Emerald’s interest in the LLC was warranted. The plaintiffs had obtained a charging order and sought foreclosure under the South Carolina Uniform Limited Liability Company Act, which allowed the court to charge the distributional interest of the judgment debtor to satisfy the judgment. The statute provides that a charging order constitutes a lien on the judgment debtor’s distributional interest and that the court may order foreclosure of a lien on a distributional interest subject to the charging order at any time. The plaintiffs first argued that the trial court erred by considering other provisions of the LLC statute providing alternative remedies weighing against foreclosure on the charging order. The supreme court concluded that the trial court improperly considered unavailable remedies (e.g., forced dissolution or the compelled purchase of the member’s interest) as weighing against foreclosure. The court stated that the plaintiffs confirmed their judgment, obtained a charging order, and sought foreclosure not as members of an LLC but as judgment creditors. The plaintiffs’ status as judgment creditors did not give them the legal right to seek dissolution or other relief under the LLC statute, and the charging order provision states that it is the exclusive remedy for a judgment creditor seeking to satisfy a judgment through the debtor’s interest in an LLC. The court held that there were no other available remedies, and the trial court’s conclusion that the availability of other remedies weighed against ordering foreclosure was in error. Next, the plaintiffs contended that the trial court erred when it considered foreclosure to be a “drastic remedy.” The court agreed that the trial court incorrectly characterized the seriousness of foreclosure. The court acknowledged that foreclosure is more drastic than simply charging a member’s distributional interest in an LLC but stated that foreclosure is a remedy commonly used when a charging order on a debtor’s interest alone will not result in payment of a judgment or more generally to satisfy a debt. In addition, the LLC statute provides no indication that foreclosure is “drastic” or only to be used in extreme circumstances. The court stated that a judgment creditor has a right to collect on a judgment, and characterizing the remedy of foreclosure as drastic wrongly implied that to foreclose on a charging order a debtor must make a showing beyond the simple necessity of foreclosure. The plaintiffs also argued that the trial court erred when it considered foreclosure to be a form of forfeiture. Again, the supreme court agreed. Forfeiture, according to the court, is a penalty. However, foreclosure is the ultimate remedy for collection of a debt owed rather than a penalty. Foreclosure does not divest the member of his or her interest in an LLC without compensation or cause a loss of the interest. The member simply has a debt that must be paid, and the debtor could avoid foreclosure by paying the judgment. Finally, setting aside the trial court’s errors, the plaintiffs asserted that the trial court erred in denying foreclosure. The supreme court agreed and held that foreclosure was warranted. The court stated that the decision whether to grant foreclosure requires consideration of the totality of the circumstances. Here, the court said that the trial court failed to consider and make findings as to the likelihood of the judgment being satisfied through distributions within a reasonable amount of time, a primary and typically determinative factor. Therefore, the trial court erred in denying foreclosure. According to the supreme court, had the trial court considered whether the judgment would be satisfied through distributions, it could only have found that distributions would not be made in the foreseeable future. Specifically, the charging order had existed almost three years without satisfaction, the LLC’s equity was shrinking each year as the liabilities steadily grew, and the LLC could only pay its debts due to loans made by Kriti and affiliated entities. Distributions under such circumstances were not permitted under the operating agreement. In addition, Kriti could not be expected to make a capital contribution when Emerald continued to impede the LLC’s business, and there was no evidence that Kriti engaged in misconduct, mismanaged the LLC to avoid making distributions, or acted outside its business judgment. Finally, Kriti attempted to give Emerald a way out of the LLC without the loss of its capital contribution by offering to purchase Emerald’s interest, but Emerald refused. Emerald and Longman were in the position they were in because of their wrongful acts, and to the extent the parties’ conduct was relevant to the decision of whether to grant foreclosure, the court found the evidence weighed against the defendants. Thus, the court remanded for the foreclosure on the sale of Emerald’s interest in the LLC through the normal foreclosure process and without further delay.
401 S.W.3d 855 (Tex. App. 2013)
The plaintiff operated a heating and air conditioning business and entered into a master purchase order agreement providing for the sale and purchase of goods with David Powers Homes, the assumed name of DJPH, LLC. Several business entities were associated with this LLC. Between 2000 and 2009, it was undisputed that a corporation affiliated with the LLC paid the plaintiff for hundreds of jobs. In 2008, the plaintiff sued the corporation and David Powers individually for unpaid balances from approximately 50 jobs involving the sale of air conditioning equipment and labor. The LLC and its affiliated entities ceased operating in 2009. The affiliated corporation sued by the plaintiff in this case filed a sworn pleading confessing judgment in 2010, and the plaintiff nonsuited the corporation, but the plaintiff continued to sue David Powers individually to recover payment and alleged that Powers was individually liable for breach of contract, fraud, and alter ego. Powers filed a motion for summary judgment, which the trial court granted. On appeal, the plaintiff argued that the trial court erred in granting summary judgment. The court of appeals first rejected the plaintiff’s contract claim. The plaintiff argued that the true identity of David Powers Homes was Powers, or that there at least was a fact question, and that the plaintiff presented evidence establishing an exception to the statute of frauds. Powers argued that he was not a party to the agreement and that the actual party was the LLC for which David Powers Homes was an assumed name. Both parties acknowledged that the contract was subject to the statute of frauds as a contract for the sale of goods over $500 and, as such, not enforceable unless signed by the person against whom enforcement is sought. The court rejected the plaintiff’s arguments that two exceptions applied here: (1) that Powers admitted he had a contract with the plaintiff, and (2) partial performance. The court of appeals examined the evidence and concluded that there were no admissions by Powers that he had a contract with the plaintiff and that the evidence did not show Powers, as opposed to a business entity, performed under the agreement. Summary judgment was thus proper on the breach of contract claim because there was no enforceable agreement against Powers as a matter of law. With respect to the trial court’s summary judgment on the fraud claim, Powers argued that the plaintiff did not plead or offer evidence that the fraud was perpetrated primarily for Powers’ direct, personal benefit, as required under Texas law to pierce the LLC veil. The plaintiff countered that it was seeking to hold Powers individually liable for common law fraud rather than seeking to pierce the LLC veil. The appellate court concluded that the only theory of fraud available to the plaintiff was one characterized as piercing the LLC veil based on the plaintiff’s pleadings, summary judgment response, and evidence. The plaintiff alleged that Powers was individually liable because he used the corporate fiction to commit fraud and contended that Powers misrepresented the identity of David Powers Homes, assured payment of debts, and used an assumed name as a mechanism to escape debt. The plaintiff further alleged that David Powers Homes and Powers were inextricably tied together under an alter ego theory. Together, the allegations were based on the premise that Powers used the LLC and its affiliates in a fraudulent manner, which required proof that Powers perpetrated fraud for his direct, personal benefit. The appellate court concluded that the plaintiff produced no evidence of any acts by Powers in his individual capacity distinct from the LLC and its affiliates, and there was no evidence that Powers abused the entities primarily for his direct, personal benefit. In addition, there was no evidence of acts by Powers to deceive or mislead explicitly or implicitly. The only evidence presented by the plaintiff was evidence that the plaintiff’s employee worked directly with Powers as representative of “David Powers Homes” and that Powers did not volunteer that this was not an assumed name of Powers individually. The appellate court stated that even viewing this evidence in the light most favorable to the plaintiff, it was no evidence that Powers committed fraud so as to justify piercing the LLC veil.
295 P.3d 231 (Wash. 2013)
In 1997, Humphrey Industries Ltd. (“Humphrey” ), Scott Rogel, Joseph and Lee Ann Rogel, and ABO Investments formed Clay Street Associates LLC (“the LLC”) to purchase and manage a piece of real property in Washington. A dispute arose in 2004 when Scott Rogel sought to sell the LLC’s property and dissolve the LLC to satisfy his divorce settlement. The LLC’s operating agreement required unanimous consent to sell the property, and Humphrey refused to consent to the sale. The other members circumvented the unanimity requirement by forming a new LLC, which they merged with the original LLC. Humphrey received notice of his statutory right to dissent, which it exercised, and Humphrey demanded payment of the fair value of its interest in the LLC. The parties disagreed on the fair value of the property and the time in which the LLC paid Humphrey for its interest, and Humphrey filed suit. The trial court found the value of the LLC as of the date of the merger and the amount that Humphrey was owed. The trial court denied Humphrey’s request for attorney fees, holding that the LLC substantially complied with the statutory deadline for payment of fair value; however, the trial court did award fees and expenses to the LLC and Joseph and Lee Ann Rogel (“the Rogels”) based on its finding that Humphrey acted arbitrarily, vexatiously, and not in good faith in pursuing its dissenter’s rights claim. The court of appeals affirmed. The Washington Supreme Court reversed the award of attorney fees imposed on Humphrey because the record did not establish that Humphrey acted arbitrarily, vexatiously, and not in good faith, and the court remanded to determine whether Humphrey was entitled to attorney fees for the LLC’s failure to meet the statutory deadline. On remand, the trial court awarded Humphrey part of its attorney fees but also reinstated part of the attorney fees awarded against Humphrey that the court had reversed. Humphrey appealed directly to the supreme court arguing that the trial court erred in not following the supreme court’s ruling and imposing attorney fees against Humphrey in favor of the LLC and the Rogels. Humphrey argued the trial court was only to consider whether the LLC owed Humphrey attorney fees for failure to substantially comply with the statutory provisions regarding payment of fair value. The supreme court agreed and found that the law of the case precluded the trial court from revisiting issues that it found supported the award of attorney fees against Humphrey because the issues had been resolved by the supreme court. The supreme court held that it was error for the trial court not to apply the supreme court’s holding that Humphrey’s conduct did not meet the standard to support and impose attorney fees on Humphrey. The trial court was not authorized to reconsider imposing attorney fees against Humphrey, and the supreme court reversed the attorney fees that the trial court awarded the LLC and the Rogels on the previous remand. Furthermore, the trial court abused its discretion by denying Humphrey the prejudgment interest it sought on the reversed attorney fees award Humphrey originally satisfied. The court rejected Humphrey’s argument that the individual members of the LLC should be held liable for the LLC’s obligations to Humphrey. The court recognized that members of an LLC generally are not personally liable for the LLC’s debts, obligations, and liabilities. Under Washington law, a member may become liable to the LLC or its other members for an act or omission that constitutes gross negligence, intentional misconduct, or a knowing violation of the law, and a member may become liable to the LLC if the member receives a distribution from the LLC knowing that the LLC would not be able to pay its debts or that the LLC’s debts would exceed its assets. Humphrey argued that the other members received distributions knowing the LLC would not be able to satisfy its obligations to Humphrey. The court stated that Humphrey did not support this argument and that Humphrey’s theories of liability would require the court to conduct factual inquiries that were beyond the scope of appellate review. Thus, the court held that Humphrey did not establish the individual members were liable for the obligations owed to Humphrey as a dissenting member in the litigation. Finally, the court held that Humphrey was entitled by statute to recover fees from the LLC for this appeal because the LLC failed to substantially comply with the LLC statute. The court declined to award fees for the trial court proceedings on remand. The court rejected other arguments by Humphrey for recovery of fees from the members. Humphrey argued that he was entitled to recover fees from the other members under a fee-shifting provision in the LLC operating agreement, but that provision provided for fees incurred in enforcing the operating agreement, and the appeal did not concern enforcement of the operating agreement. Humphrey also argued that the LLC’s members were liable for attorney’s fees under other exceptions to the American Rule. Humphrey argued that the members were liable due to their bad faith, but the court stated that bad faith had not been established. Humphrey relied on the fiduciary duty owed among partners to argue that the members were liable for fees for breach of fiduciary duty, but the court pointed out that this argument assumed that the same duty exists among members, and the court refused to consider that issue.
__ F.Supp.2d __, 2013 WL 441476 (E.D. Wis. 2013)
The two members of a Wisconsin LLC, Halaska International, Inc. (“Halaska”) and Carhart, Inc. (“Carhart”), had a contractual dispute, and Halaska sued Carhart and its owner in state court. Halaska named the LLC as a plaintiff in addition to Halaska. The defendants removed the case to federal court based on diversity of citizenship. Since the citizenship of an LLC is the citizenship of its members, citizens from the same state were on both sides of the case (i.e., defendant Carhart was a citizen of Illinois, which meant the plaintiff LLC was also a citizen of Illinois), thus destroying diversity of citizenship; however, the defendants alleged that the federal court should disregard the LLC’s citizenship because it was an improper plaintiff. The defendants relied on the fraudulent joinder doctrine, which allows a court to disregard citizenship of a party joined to defeat diversity jurisdiction. The court noted that the Seventh Circuit has never endorsed the use of the fraudulent joinder doctrine to disregard a plaintiff’s citizenship and that the burden to establish fraudulent joinder is very heavy. To prevail on the claim of fraudulent joinder, the defendants had to show that the plaintiff actually committed fraud in naming the LLC as a party or that there was no reasonable possibility that the LLC could prevail on any of its claims taking all inferences of fact and law in the LLC’s favor. The defendants first argued that there was no reasonable possibility that the LLC could prevail because Halaska was not authorized to join the LLC as a plaintiff. The Wisconsin LLC statute provides that an action on behalf of an LLC may be brought in the name of the LLC by one or more of its members if the members are authorized to sue by the affirmative vote of a majority in interest of the members, except that the vote of any member who has an interest in the outcome of the action that is adverse to the interest of the LLC must be excluded. Wisconsin case law has held that an LLC’s operating agreement must explicitly address voting to authorize an action on behalf of the LLC in order to override this statutory provision. The operating agreement between Halaska and Carhart prohibited a manager of the LLC from bringing suit on behalf of the LLC unless a certain procedure was followed, however it did not address member-initiated suits or voting to authorize such suits. Thus, the LLC’s operating agreement did not override the statute governing the member’s authority to sue on behalf of the LLC. The next issue was whether Halaska satisfied the governing statutory requirements, and specifically whether Halaska’s interest was adverse to the LLC thus excluding Halaska from suing on the LLC’s behalf. The defendants contended that Halaska’s interest was adverse to that of the LLC because Halaska sought to compel the LLC to provide funds to pay tax obligations. Based on Halaska’s complaint, the court could not say that Halaska’s interest was adverse to the LLC because Halaska alleged that it sought to recover funds that were allegedly misappropriated by the defendants from the LLC. Halaska was thus authorized to join the LLC as a plaintiff because it met the percentage of LLC ownership to satisfy the affirmative vote requirement. Finally, the defendants argued that Halaska failed to follow the appropriate procedure with respect to initiating the suit because Halaska did not seek a vote at a meeting of the LLC members and did not memorialize its consent in writing until after it filed suit. The Wisconsin statute does not require a formal vote or written consent; it requires a complaint to particularly describe the authorization for the member to bring the action. The court found that Halaska’s complaint met the statutory requirement and that Halaska followed the appropriate procedure in initiating the suit. Thus, there was a reasonable possibility that the LLC could prevail on its claims against the defendants, and applying the fraudulent joinder doctrine would be improper. Since the citizenship of the LLC could not be disregarded, the court remanded the case to state court due to lack of subject matter jurisdiction.
C.A. No. 7668-VCN, 2013 WL 209124 (Del. Ch. Jan. 18, 2013)
(right to expedited discovery and hearing on preliminary injunction in connection with claim that managing member made improper tax distribution to itself)
__ F.Supp.2d __, 2013 WL 3179432 (E.D. La. 2013)
(limited liability of parent company of LLC’s sole member with respect to plaintiff’s injury at refinery owned by LLC )
485 B.R. 20 (D. Mass. 2013)
(insufficiency of evidence to establish that sale of LLC’s assets to another LLC was done with intent to defraud creditors; sufficiency of evidence to support imposing successor liability on purchasing LLC as mere continuation of selling LLC)
__ F.Supp.2d __, 2013 WL 1491894 (D.N.M. 2013)
(foreign LLC’s ability to assert counterclaim after registration to transact business despite being unregistered when counterclaim was filed)
960 N.Y.S.2d 135 (App. Div. 2d Dept. 2013)
(submission of operating agreement of LLC defendant as refuting LLC’s allegation that plaintiff in foreclosure action knew or should have known of managing member’s lack of authority to mortgage LLC’s property)
Bankr. No. 11-60242, Adv. No. 11-6011, 2013 WL 1084494 (Bankr. E.D. Tex. March 14, 2013)
(fiduciary duties of managing member to LLC; absence of fiduciary relationship between managing member and other members of LLC; exception to discharge from bankruptcy for defalcation in fiduciary capacity by managing member